Business Cycle Properties and Macro Forecasting of the Australian Economy - Case Study Example

Executive Summary This empirical report looks at the business cycle properties and macro forecasting of the Australian economy. The analysis of economic data and policies help to make economic and or managerial decisions from an informed position. The report analyses and interprets key economic indicators and produce economic reports. The data used in this empirical are solely for Australia covering the period 1996 to 2011. The report has used several indicators in order to better understand the macroeconomic conditions and make more informed macroeconomic forecasts. These indicators include; inflation rate, nominal exchange rate between Australia and the US, private final consumption, inventory investment, unemployment rate, labour productivity, interest rate (both short term and long term), money supply and trade balance. The report has used correlation with output and cross correlations with output as the statistical means of summarizing the data. The report has addressed the cyclical nature of each of the variables and the indicator properties. A statistical summary using graphs has been provided, in addition to providing economic explanations on the movements of these indicators. The report has provided forecasts for; real GDP growth for 2011 quarter 4 and 2012 quarter 1, inflation rate for 2011 quarter 4 and 2012 quarter 1, the extent to which the RBA will change the cash rate, the average exchange rate between the Australian dollar and the US dollar and the percentage change in Australian House Price Indexes. Business Cycle Properties and Macro Forecasting of the Australian Economy Introduction Every business goes through the normal business cycle. There is no business which maintains its growth momentum throughout its life (Fisher, Otto and Voss, 1996). This is mainly because there are some exogenous variables which are not under the direct control of the business. A business will exhibit a series of peaks and troughs during its cycle. Macro forecasting of the economy is essential as it helps to monitor the booms and recessions in the economy (Watson, n.d). These forecasts help to put measures in place in order to prevent the business from going under during economic recessions. According to Conference Board (2010) economic data and policies are usually analyzed so as to help make well informed economic and/or managerial decisions. Data are produced now and then throughout the year. They are usually aggregated into quarterly or monthly. The ‘Federal Reserve Bank of Philadelphia’ (2010) insists that in order to avoid wide fluctuations the data need to be seasonally adjusted. This is usually done by removing the trend or expressing the data in growth terms for most aggregate variables with a long term trend. It is stated in Economagic (2010) that this transformation produces economically meaningful plots and tables. Other means of forming a meaningful data include the combination of variables. For instance, labour productivity data is obtained by combining output and labour force. Task 2 i. Real GDP growth for 2011 quarter 4 and 2012 quarter 1 is 0.808%. This is the average rate at which real GDP is growing. The GDP is showing a constant growth of 0.808%, which means is not likely to fall below this rate. The long term interest rate is likely to fall in order to encourage private investment, which will result in increased output. However, the exchange rate will increase, which will encourage other countries to buy from Australia since the exports will be relatively cheaper. This will help in maintaining the growth rate in GDP. ii. The inflation rate for 2011 quarter 4 and 2012 quarter 1 is 2.6592%. This inflation rate is the average inflation over the years. The average inflation rate will prevail during these quarters since it does not show wide fluctuations (ABS, 2011). If the inflation rate is maintained at this level it will help to boost output since the purchasing power for investment goods will not be negatively affected. The nominal long term interest rate will be adjusted upwards in order to cushion for the anticipated inflation. Exchange rate will be high because of the effects of inflation, which tend to weaken the value of the currency. iii. On Tuesday, November 1, 2011, the RBA will not change the cash rate since the economy will be experiencing a boom. However, on Tuesday, June 5, the RBA will change the cash rate by 0.5%. This will help to lower the interest rates, which will make investment goods cheaper. The effect will be a boost in the aggregate output during this recessionary period (Reserve Bank of Australia2001). Changing the cash rate will not have any direct effect on exchange rate; however, its effect on interest rate will be transmitted to the exchange rate. This will force the policy makers to adjust the exchange rate. iv. The average exchange rate between the Australian dollar and the US Dollar to prevail from November 1, 2011 to June 30, 2012 is 0.9620. This exchange rate will enable the Australian export to be attractive to the US. This will have the effect of improving the trade balance hence boosting the aggregate output. This exchange rate will be important in maintaining the long term interest rate, which encourages long term investors to invest in the country. Low interest rates discourage investors and results in decline in GDP. v. The year-over-year percentage change in Australian House Price Indexes in Q4 2011 (relative to Q4 2010) as measured by the Australian Bureau of Statistics 6416.0 - House Price Indexes: Eight Capital Cities is -1.9%. This is found by finding the total house price indexes in Q4 2011 and Q4 2010. The change is then divided by the totals of Q4 2010 and then multiplied by 100 in order to get the percentage change (Handerson, 1987). A decline in House Price Indexes will cause a subsequent fall in levels of inflation, which will necessitate a corresponding decline in long term rates of interest. The decline in House Price Indexes will attract foreign investors, which will cause the value of AUS Dollar to appreciate. Conclusion The report has looked at the business cycle properties and macro forecasting of the Australian economy. The analysis has shown that favourable exchange rate and inflation rate help to boost the output in the economy (Walter, 1991). When inflation rate is high, it reduces the purchasing power of income, in addition to depreciating the value of the currency. A weak currency causes imports to be more attractive than the export, which result in a decrease in GDP. Exchange rate should be maintained at the minimum in order to encourage US to demand Australian product. This improves the trade balance since exports will be higher than imports. Interest rate has an inverse relationship with investment. Therefore, long term interest rate should be low in order to make investment less expensive. The RBA has the power of influencing the direction of the interest rate by varying the “official cash rate”. The effect of changing “official cash rate” is transmitted down to demanders of capital goods. Therefore, “official cash rate” should be reduced in order to make interest rate to be low. A low interest rate makes the cost of investment to be low (Wirick, 1998). Increased investment improves growth in GDP as it is a component of the GDP. References ABS, 2011. Labour force. [Online] Available at: [Accessed 30 September 2011] Conference Board, 2010. Strategic work force planning. [Online] Available at: [Accessed 30 September 2011] Economagic, 2010. Australia data of the Reserve Bank. [Online] Available at: [Accessed 30 September 2011] Federal Reserve Bank of Philadelphia, 2010. Regional Economy. [Online] Available at: [Accessed 30 September 2011] Fisher, L., Otto, G. and Voss, G., 1996. Australian Business Cycle Facts. Australian Economic Handerson, J., 1987. Microeconomic Theory. New Jersey: McGraw-Hill Publisher. Papers, 35(67), pp.300-320. Reserve Bank of Australia, 2001. Monetary policy meeting of the reserve bank board. [Online] Available at: < http://www.rba.gov.au/Statistics/> [Accessed 30 September 2011] Walter, N., 1991. Microeconomic Theory: Basic Principles and Extensions. New Delhi: Dryden Press. Watson, M., n.d. Macroeconomic Forecasting: entry for The New Palgrave Dictionary. 2nd edition. Wirick, D., 1998. Organizational transformation: ensuring the relevance of public utility commissions, New Jersey: National Regulatory Research Institute. Read More