European origins of economic development - MyAssignmenthelp.com

Question: Discuss about the European origins of economic development. Answer: Introduction Australia is well known for its mixed economic structure and highly developed nature. It is one of wealthier nations of world. Both in terms of nominal GDP and PPP-adjusted GDP Australia is ahead of several nations. When compared with per capita GDP, Australia ranks ahead of Canada, Germany, UK and France. Agriculture in Australia constitutes 3% of GDP. The large stock of natural resources especially minerals helps to build a strong mining sector. Despite having several industries, the contribution of manufacturing in economic growth has declined in recent years. This gap is filled with growth of service sectors especially financial services. Four largest banks in Australia are listed among 50 safest banks of world. Australia has a comparative advantage over a range of goods and services including products with high technology like scientific and medical equipment, processed food and high quality wine. The service exports of Australia include tourism and education, financial and prof essional services. Along with domestic sectors, trade has made significant contribution to economic growth of Australia. In the current research paper, performance trend of Australia is evaluate using some of the basic indicators. Economic growth is captured from the movement of real GDP which in turn affects employment and price level. Cash rate controlled by monetary authority influences investment and growth. The performance of external sector depends on the trend exchange rate and balance of trade. Performance Analysis Evaluation of economic relation between GDP and other important variables Gross Domestic product of a nation is measure of the value of goods and services of a nation in money terms. All the produced goods and services are evaluated in terms of their market price. Now, there are two approaches for computing GDP. One is to use market price for the accounting year and other is to consider prices of a fixed based year. The former is called nominal GDP while the latter is known as real GDP (Baumol and Blinder, 2016). Real GDP being adjusted for inflation is a more accurate measure of economic output and hence growth. For this, while evaluating economic growth of Australia real GDP is used. Figure 1: Trend in real GDP (Data source: data.worldbank.org, 2018) The figure above shows trend in real GDP for the chosen sample period. Mean growth rate in Australia for the period is 3.1%. The growth rate has constituted a fluctuating trend flowing crisis in domestic and international economies. A steep fall in the growth rate is experienced during 1991. The growth becomes negative. The tight monetary policy undertaken by Reserve bank of Australia is one major contributor of negative economic growth during this time. However, the economy gradually recovered and attained a maximum growth rate of 5.1% in 1999. Beyond 1999, the growth rate though fluctuates and undergone with some upturn and downturn but remain positive and around its average trend. Australia being closely related with United States was supposed to be affected from mortgage crisis occurred in US during 2008 (Easterly and Levine, 2016). However, the support from Australian government in the form of a stimulatory package of $11.8 billion and a relatively strong banking and financial s ector has helped to minimize the recession risk. Growth rate though fell after 2008 but remain positive and close to 2%. GDP is the sum of expenditure incurred in an economy in the given year. It includes consumption expenditure, investment expenditure, government spending and net export. Therefore, each component has direct relation with GDP (Acemoglu, Laibson and List, 2017). After analyzing trend growth rate now the relation between GDP and other macro variables are examined. Correlation matrix Correlation is a statistical tool to find out a general relation between two or more variables. The correlation between GDP and chosen variables is computed using general the historical data of twenty-six years. Table 1: Correlation between GDP and five indicators Real GDP growth rate Interest rate (Cash rate) Unemployment rate Inflation rate Exchange rate (AUD/US) Net export Real GDP growth rate 1 Interest rate (Cash rate) -0.08 1 Unemployment rate -0.13 0.28 1 Inflation rate -0.03 0.64 -0.23 1 Exchange rate (AUD/US) 0.20 0.04 0.26 0.08 1 Net export 0.23 0.26 0.55 -0.02 0.85 1 The correlation matrix shows GDP has a positive relation with some variables and negative relation with some others. The variables with which GDP is positive related include exchange rate and net export. The variables such as interest rate, inflation and unemployment rate constitute a negative relation with GDP. There are economic explanations behind the statistical relationship obtained from the collected data. The first variable considered is the interest rate. The interest rate that is taken here is the cash rate or the rate charged by RBA on loan borrowed by commercial banks from the reserve bank. When RBA charges a high interest rate then this means a high cost for commercial banks for borrowed capital. This high cost is reflected from the interest rate charged by these banks on borrowed fund for investment. The investors when experience a high interest rate then they reduce their investment (Agnor and Montiel, 2015). This by contracting productive activities reduces GDP. Opposite is the case in times of a low cash rate. This explains the inverse relationship between the two variables. The unemployment rate in the economy is negatively related with GDP growth. The economic rationale behind this is quite simple. A growing trend in GDP means expansion of output. Expansion of in production of goods and services means a greater demand for labor force and hence a reduced unemployment rate (Madsen and Olesen, 2016). Inflation is both a cause and effect of higher GDP. When GDP grows, average income of people rises, demand enhances and push prices up. From the other end, when price level rises because of increased demand then more goods and services are produced and hence bring economic growth. However, for Australia inflation has resulted from increasing production cost and hence raises debt of household and business (tradingeconomics.com, 2018). Therefore, in case of Australia an opposite relation between inflation and GDP growth is found. The exchange rate represents the cost of purchasing some other countrys currency in terms of its domestic currency. The unit price of US dollar in terms of Australian dollar is considered for analysis. A rise in exchange rate means Australia now have to pay a higher amount to have one unit of US dollar than earlier. This deprecates Australian currency while appreciate US dollar. People in US now can demand a larger amount of Australian goods and service. This stimulates export demand and brings economic growth (Horwich and Samuelson, 2014). Therefore, a positive relation exits between exchange rate and GDP. Net export implies the balance of trade of a nation. A rising net export mean the country is earning more from export than its import spending and hence GDP rises. This therefore supports the positive correlation obtained between net export and GDP growth. Cash rate Figure 2: Trend in interest rate (Data Source: rba.gov.au, 2018) There is a gradual downfall in the cash rate. The cash varied for the time period varied in the range of 15.23% to 2.13%. The high cash rate during 1990 signifies a tight monetary policy of Australian government. However, economic recession in 1991 causes RBA to switch from a tight monetary policy to a monetary easing (Muffels, 2014). After recession year, cash rate though fluctuates but in mostly remain close to an average rate of 5.63%. In recent years, in order to achieve a targeted inflation of 2-3% RBA significantly reduces interest rate. This is indicated from a continuous fall in interest from 2012. The cash rate is now at a fairly stable rate of 1-2%. Inflation rate Figure 3: Price level trend in Australia (Data Source: data.worldbank.org, 2018) The consumer price inflation reflects change in average prices to maintain a certain standard of living between two different periods. In Australia, the mean inflation rate is 2.73%. RBA plays an important role in maintain stability in the price level (Lin and Cheng, 2016). The price level sharply fell in 1991 to 3.22% from 7.27% in the previous year. In times of Asian financial crisis price level reached to its lowest level of 0.25%. In order to recover the economy from recessionary trap stimulus has given with fiscal and monetary policy tool (Denny and Churchill, 2016). Finally, the economy is successful in achieving a stable price level ranging between 1 to 2 percent. Unemployment rate Figure 4: Trend in unemployment rate (Data Source: rba.gov.au, 2018) With a stable growth and inflation rate, unemployment in the economy has constituted a gradual declining trend. After achieving a maximum level of 10.90 percent in 1993, unemployment continuously fell and attained the lowest level of 4.20 percent in 2008. From 2008, unemployment rate has risen slightly and moves around 5-6%. Most jobs created in recent years are part time in nature (Makin, Robson and Ratnasiri, 2017). There are also mismatch in terms of location and skills of the unemployed people with that of the new jobs created. Therefore, despite increase in labor force participation unemployment rises. Exchange rate Figure 5: Movement of Exchange rate (Data Source: data.worldbank.org, 2018) The movement of exchange rate is not much fluctuating. The average price of US dollar relative to Australian dollar is 1.35. The exchange rate reached an all-time high of 1.93 in 2011 and lowest level of 0.97 during 2011-12. Net export Figure 6: Trade balance in Australia (Data Source: rba.gov.au, 2018) The trend in balance of trade reveals that Australia has enjoyed a trade surplus until 2007. Australia had a maximum trade surplus of 66.706 AUD billion in 2001. The maximum trade balance is associated with the highest exchange rate of 1.93. During 2008, Australia experienced a negative trade balance because of a reduction in export volume to US following the financial crisis originated in the end of 2007.During this time Australian dollar appreciated significantly causing a rise in import (Bhatnagar et al., 2017). The maximum trade deficit was realized in 2012 with net export became -51.198 AUD billion. The exchange rate fell to 0.97 during this time. Relationship between inflation and unemployment The general relationship between inflation and unemployment is explained by the popular macroeconomic concept of Phillips curve. The curve slopes downward implying an inverse relation between unemployment and inflation. In the short run, with increase in inflation unemployment rate falls and vice versa. The rationale behind this is simple. Price level increases from an increases in demand in the economy. The increased demand encourages production of goods and services. Hence, increased demand for goods and services is associated with an increased demand in the factor market. As labor demand increases unemployment decreases (Haas and Sattler, 2017) However, in the long run unemployment rate is fixed at its natural rate of unemployment and the Phillips curve is a vertical line over long run. Figure 7: Short run and long run Phillips curve (Source: Baumol and Blinder, 2016) The theoretical relation between inflation and unemployment is now verified empirically using historical data for Australia. The correlation as estimated from the data is -0.23. Therefore, the proposition of Phillips relation is supported in Australia. That means a small inflation is associated with a high unemployment rate. With increases in inflation unemployment reduces. In the beginning years of the decade 1990, unemployment has a clear opposite relation with inflation. After the hit of recession in 1991, the contraction of the economy reduces price to a considerable low level. This low inflation is then associated with high unemployment of above 10 percent. With gradual recovery of the price level unemployment reduces (Belicka and Saleh, 2014). However, overtime stable price level becomes one of the policy target of reserve bank. The wave of global financial crisis in 2008, inflation fell to 1.82. During this time unemployment rate slightly rose to 5.20 percent. Finally, with inflation targeting policy of RBA the price level stabilized between 1 to 2 percent (Trott, 2015). Despite a very low inflation rate unemployment rate still remains at around 6 percent. Figure 8: unemployment and inflation relation (Data Source: data.worldbank.org, 2018) Tight Monetary Policy in Australia Fiscal and monetary policy are the two stabilizing instrument used by Australian government. Depending on the state of economy, expansionary or contractionary policies are undertaken by the government. A tight monetary policy is one where RBA raises interest rate to a considerable high level. The increased rate increases the cost of borrowing and reduces investment. The reduced investment pulls down demand and inflation (Davig and Gurkaynak, 2015). In Australia, the monetary policy is designed by Reserve Bank of Australia. RBA resorted to a tight monetary policy during 1980. To reduce inflationary pressure, RBA set the cash rate to an exceptionally high level. The cash rate in 1991 was 15.23 and in 1992 it was at 10.64%. For the entire time framework considered, cash rate was never as much as that in these two years. The policy proved to be a failure after the recession occurred in 1991. The economy learned from its recessionary experience and realized the need for monetary easing. M onetary policy slightly tightened from 2004 to 2008 when RBA continuously raised the cash rate but at a relatively slow rate (rba.gov.au, 2018). However, from 2008 till date RBA again shows support to an easy monetary policy and maintains a low cash rate. Economic Outlook In the near future, the economy will continue to grow at a robust pace. With investment stimulus in sectors other than mining and housing aggregate demand will be increased. Additionally, export sector will grow with explored newly explored capacity of new resource sector. The employment growth by increasing average income will increase household consumption. Wages in the economy will grow gradually and price level will remain fairly stable. The sound fiscal position will provide necessary support in future and will maintain a projected growth rate of 3-4% (abc.net.au, 2017). With this, there is least risk future recession and more chance for further prosperity. Conclusion The paper has made close evaluation of economic performance of Australia. Australia has performed quite well in the last few years. The economic growth rate is fairly stable with a stable price level and improvement in employment status. Despite a negative external balance, the export sector has scope for future growth. The Reserve Bank has extended support towards a stable growth by keeping cash rate to a low level. The growth trend is expected to continue in future with overcoming possible shocks of recession. References ABC News. 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