Global Export Prices of Australia - Essay Example

? Macroeconomic Contents Introduction 3 Question a 3 Question b 4 Question c 6 Conclusion 8 References 9 Bibliography 10 Introduction High terms of trade are the characteristics of the current economy of Australia. It can be witnessed that the terms of trade has fallen in the recent months yet the rate has been historically high and volatile. The level of real income rose as the result of high terms of trade as well the inflation rate got reduced. The ratio between the prices of exports and the prices of imports are regarded as the terms of trade. With high rate of terms of trade the country will be able to obtain higher imports with relatively fewer amounts of exports. The volatility in the expenditures made by the consumers can be explained by the volatility in the terms of trade. The economy of Australia can be characterized by less volatile terms of trade after the period of 1980s. It can be judged that economic growth shares close association with terms of trade. An economy moving along the growth curve is expected to witness terms of trade while the economy under the growth curve will face the declining terms of trade line. Question a The global prices of the exports as well as the imports and the goods basket offered to the consumers are the two prime components that make up the terms of trade. Australia can be treated to be the country that has the potential to affect the world prices of the goods. The terms of trade can also get influenced by the geographic boundary of an economy. Coal is abundant in the country and therefore Australia engages itself in coal export (Department of Foreign Affairs and Trade, 2011). A rise in the prices of coal relatively to the prices of the other ICT goods will shed the effect in rising the terms of trade. The exchange rate of the economy and the terms of trade are closely associated. The nominal exchange rate got reduced being the resultant of financial crisis of 1990s. The influences with the geographical boundaries can play a part in volatility of import prices but the prices of the exports are influenced only by changes in world prices of the goods. In the short time period the fall of imports are steeper than the price of exports. The unstable growth in productivity in the sectors of tradable or non tradable goods played a part in boosting the exchange rate. The phase after the 1980s led to rapid productivity growth in the sectors of finance as well as insurance. The inflows of capital paved the way for strengthening of the U.S. dollar and this can be accounted to be the second factor. In the short run the exchange rate remained lower than the market rate. The economic growth remained at more or less at relatively stable state as the volatility in terms of trade played a major role. The less volatility in the terms of trade also contributed in keeping the rate of inflation at a lower level. In the initial phases of the new millennium the terms of trade began to rise. Over the last decade and a half Australia shifted from exporting price impulsive properties towards exports of goods whose price can be anticipated. Australia now engages itself in exporting the rural goods. It offers a wide variety of goods for export and experts are of the opinion that the export of the rural goods is an effective strategy for the country as exports of such goods can be assumed to capture a proportion of foreign market (Australian Government Productivity Commission, 2012). Therefore foreign capital will plight in into the country. The exports of the rural goods have taken the steep rising curve over the course of time and the exports of the goods comprises of vegetables and dairy products. Question b The terms of trade is influenced by the factors that are summarized below. The fluctuation in the levels of demand on the global platform The shocks in the market of commodities Globalization shock The fluctuations in the levels of demand on the global arena and the shocks on the commodity markets plays their part in raising the prices of the exports while the globalization shock contribute in reducing the import prices (RBA, 2012). The first two factors can also raise the total productivity growth. The impact of the first factor can be anticipated to be felt in the short run and the rate of inflation can also be expected to rise up. The real exchange rate will appreciate along with high rate of interest. The Mundell-Fleming model comprises of the IS and the LM curve. The difference between the exports and imports equals to net exports. The gross domestic product of any economy is regarded to be the sum of investment, consumption, net exports and expenditure from the part of the government. The following equation represents the equation of the LM curve. The balance of payments curve is important in the model. The addition of the current account as well as the capital account surplus denotes the balance of payments. A rise in the spendings of the goevrnemnt will shift the IS curve to the right. The rate of interest will rise as a result. With the exports fo goods foreign capital will plight in into the economy and therefore the excahge rate will continue to rise (Garton, Gaudry and Wilcox, 2012., pp. 40-42). Again with the rise in global interst rates and the plight of capital away from the country will lead to rise of the balance of payments curve. In order to manage the scenario in this case the RBA will have to buy dmomestic currency and the currency of Australia will depriciate to manage the flying out of capital. The LM curve will start to shift towards the IS curve until and unless it reaches the intersection of the IS and the BOP curve. In the case of perfect capital mobility the balance of payments curve will lie parallel to the global interst rate while the real interst rate and the global interst rate will lie at the same level. An increase in governemnt spending will pave the way for the authorities to supply local currency into the economy so as to the keep the interst rate at the stable state. As depiected in the figure above the BOP curve is parallel to the horizontal axis but the case is only for the situation under perfect capital mobility. Question c The chart below depicts the performance of the Australian dollar in comparison with U.S. dollar and the TWI. With the rise in the prices of exports the equilibrium exchange rates will rise and it will lead to increase in the demand for goods of the country. The benefits of the increased investment will accrue to the resource sector while the high terms of trade will lead to increase in the consumers expenditures. The terms of trade is expected to get reduced in the near future while the commodity prices will still be cheaper. The country positions itself as risk averse and therefore the rate of interest will be low while the banks of the country will have the advantage of accessing more capital than the banks in other countries. The capital market reaped the benefits of the participation of the banks as the banks were access more capital and plays an active role in the capital market. The spending made in the resource sector will pave the way for economic progress. Currently the consumer prices are facing the barriers of beginning of carbon prices. Experts and analysts are of the opinion that the introduction of the carbon prices will produce negative effects on the economy but the effect will be felt in the years to come. The real exchange rate is higher than anticipated. The policy changes in the monetary framework will have its impact over the Australian economy but the impact will be felt after sometime. Conclusion The above discussion encircled on the reasons behind the movement in the terms of trade of Australia. The role of the movements of the import prices as well as that of the exports was taken to the prime reason. The strengthening of the dollar and the prices of the prices played the supporting role in movements of the terms of trade for the country. The relevance of the Mundell-Fleming model is response to the economy of Australia and the discussions were carried taking into consideration the characteristics of the model and response of the model on the various considerations over the economy. The macroeconomic indicators were used to verify the responses of the model. The reasons that led to shifts of the IS and the LM curve have not been discussed. The role of the monetary and the fiscal policy of the authorities of Australia on the decline of terms of trade constitute the concluding remarks. References Australian Government Productivity Commission, 2012. Terms of trade. [pdf]. Available at: http://www.pc.gov.au/__data/assets/pdf_file/0013/118111/12-coag-reform-supplement-chapter11.pdf. [Accessed: 28th December, 2012]. Department of Foreign Affairs and Trade, 2011. COMPOSITION OF TRADE AUSTRALIA. [pdf]. Available at: http://www.dfat.gov.au/publications/stats-pubs/cot-cy-2011.pdf. [Accessed: 28th December, 2012]. Garton, P., Gaudry, D. and Wilcox, R. 2012. Understanding the appreciation of the Australian dollar and its policy implications. [pdf]. Available at: http://www.treasury.gov.au/~/media/Treasury/Publications%20and%20Media/Publications/2012/Economic%20Roundup%20Issue%202/Downloads/03_Appreciation_of_the_Aust_dollar.ashx. [Accessed: 28th December, 2012]. RBA, 2012. International Market Operations. [online]. Available at: http://www.rba.gov.au/mkt-operations/intl-mkt-oper.html. [Accessed: 28th December, 2012]. Bibliography Parkinson, M. 2012. MACROECONOMIC POLICY FOR CHANGING CIRCUMSTANCES. [online]. Available at: http://www.treasury.gov.au/PublicationsAndMedia/Speeches/2012/Post-Budget-ABE. [Accessed: 28th December, 2012]. Read More