The Reasons behind the Movements in Terms of Trade for Australia - Assignment Example

These have three questions in this essay Contents Introduction 3 Question a 3 Question b 4 Question c 6 Conclusion 7 References 9 Bibliography 10 Introduction The current characteristics of the Australian economy are governed by high terms of trade. It can be accounted that the rate has taken the falling curve recently but it cannot be ignored that the rate has remained historically high. It has also been volatile. The high rate of the terms of trade plays its part in increasing the real income level. The rate also acts in keeping the rate of inflation at lower levels. The ratio between the prices of exports and the imports is defined to be the terms of trade. If the terms of trade rise Australia will have the potential to buy more imports with smaller amounts of exports. The volatility in the terms of trade can be used to define the ups and down in the expending capacity of the consumers. The terms of trade has been less volatile for Australia since the period of 1980s. Economic growth is related with terms of trade. It can be witnessed that term of trade rises when an economy is experiencing economic growth while the terms of trade falls when the economy is stagnated and is not witnessing any growth. Under such cases the terms of trade will fall (Department of Foreign Affairs and Trade, 2011). Therefore in order to analyze the terms of trade of Australia it is necessary to judge the economic growth of the country for the period under consideration. Question a The variety of goods that are offered to the consumers and the global prices for the exports as well as the imports comprises the two main components of terms of trade. The developments within the environment outside the geographical boundary of Australia can influence the terms of trade. The terms of trade can rise if the price of coal raises more steeply than the price other ICT goods since Australia is a net exporter of coal. The exchange rates and the terms of trade shares close relation. The nominal exchange rates got reduced after the financial crisis of 1990s. The volatility of the import prices can be influenced by the regional influences but changes in the global prices can affect to change the prices of exports. It can be witnessed that in the short run the price of imports can fall more steeply than the price of exports. The exchange rate can be boosted by the unstable growth in productivity in cases of tradable as well as the non tradable goods. In the period after 1980s some of the sectors like insurance and finance witnessed tremendous growth rates. The inflows of capital into the country of Australia paved the way for appreciation of dollar. It can be assessed that in the short time span the exchange rates remained relatively lower than the fundamental levels. The terms of trade again took the upward sloping curve after 2000. Over the last decade and a half Australia turned away from comparatively price impulsive properties and took the initiative towards moving towards exports of goods whose prices can be more predictable in the global market (Australian Government Productivity Commission, 2012). The rural goods now consist of a major proportion of goods that are exported. The wide ranges of exports that are practiced by Australia consist of rural goods like vegetables and dairy products. It can be experienced that the exports of such goods has grown in the recent months and can be thought as one of the reasons for Australia experiencing a high rate of terms of trade. In due course of time the exports of the rural goods have risen. Question b The factors that have the potential to influence the terms of trade have been discussed below in bullet format. The shifts in the demand level on the global arena The commodity market shocks Globalization shocks The prices of exports are raised by the joint influence of fluctuations in global demand and commodity shocks in the market. The prices of imports are reduced by the globalization shocks. The total productivity growth can also get influenced by the above discussed factors. The impact of the first factor can be felt in the short term. It can be forecasted that the rate of inflation will rise. The rate of real exchange can appreciate with high rate of interest. The IS and the LM curve together comprise the Mundell-Fleming model. The net exports are the difference between the exports and imports. The sum of investment, government spending, consumption and net exports is equal to gross domestic product. The equation of the LM curve is represented by the following equation: The balance of payments curve is important in the Mundell-Fleming model. The balance of payments is denoted by the addition of current account as well as capital account surplus. The IS curve will shift to the right with the rise in the expenditures of the government. The resultant is rise in the interest rate. In line with the exports of goods the foreign capital will flow in into the economy which will appreciate the rate of interest. The decline in the balance of payments curve will took place as capital flows out of the economy and global interest rate takes the upward sloping curve. The role of RBA is important in this situation (RBA, 2012). To take hold of the situation RBA will have to buy domestic currency and as a result the Australian dollar will depreciate. The LM will continue to shift towards the intersection of the IS and the BOP curve. The BOP curve will be parallel to the global interest rate curve in case of perfect mobility. The real interest rate and the global interest rate will be equal in case of perfect capital mobility. Increase in the government expenditure will force the local authorities to increase the supply of local currency into the economy (Garton, Gaudry and Wilcox, 2012., pp. 40-42). Such a strategy will keep the interest rate stable. In the figure the balance of payments curve is parallel to the horizontal axis but it should be noted that the case is only valid under perfect capital mobility. Question c The graph below shows the performance of terms of trade for Australia on the years under consideration. The period selected in the graph ranges from 1992 to 2007. The seasonally adjusted terms of trade have been depicted on the graph. The equilibrium exchange rate will rise with the rise in the prices of exports. The price rise in exports will pave the way for rise in demand for goods for Australia. The resource sector will reap the benefits of the increase in investment. On the other hand the consumer spending will get inflated by the high terms of trade. Experts forecast the terms of trade to take the downward sloping curve in the near future. The prices of commodities will fall i.e. the commodities will become cheaper. Australia will position itself as a risk adverse country which will reduce the rate of interests. The banks of Australia will have the relaxation to access more capital when compared to the banks in the other countries. The capital will get the benefit of the increased access of capital for the banks as the role of the banks in the capital cannot be ignored. The economic progress of Australia is scheduled ion the time line due to the expenditures made by the resource sector of the country. Presently the customers are facing barriers as the prices of carbon are on the rise. Analysts opined that the introduction of carbon prices will act as the barrier and may have negative effects on the economy but it can be rest assured that the effects will be felt on the long run. The anticipated real exchange rate will rise. The policy changes on the monetary grounds will shed the impact over the economy of the country but the presence of the policy changes will take some time to impact upon the economy. Conclusion The main points of the above discussion were to analyze the reasons behind the movements in terms of trade for Australia. The most prolific reasons that have been cited are the movements in the prices of exports as well as imports. The strengthening of the dollar and the role of the local currency played the supporting role in movements of terms of trade for the country. The characteristics of the Mundell-Fleming model along with the responses of the model were used to analyze the behavior of the economy of Australia. The responses of the model were confirmed with the help of macroeconomic indicators. The reasons that led to the shifting of the IS and the Lm curves have not been ignored. The concluding remarks were done by the role of the fiscal and the monetary policies of the concerned authorities of Australia. 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: 7th January, 2013]. 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: 7th January, 2013]. 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: 7th January, 2013]. RBA, 2012. International Market Operations. [online]. Available at: http://www.rba.gov.au/mkt-operations/intl-mkt-oper.html. [Accessed: 7th January, 2013]. Bibliography Parkinson, M. 2012. MACROECONOMIC POLICY FOR CHANGING CIRCUMSTANCES. [online]. Available at: http://www.treasury.gov.au/PublicationsAndMedia/Speeches/2012/Post-Budget-ABE. [Accessed: 7th January, 2013]. Read More