Impact of the Global Financial Crisis on an Australian Economy - Essay Example

MACROECONOMICS: IMPACT OF THE GLOBAL FINANCIAL CRISIS ON AUSTRALIAN ECONOMY Name Institution Professor Course Date Introduction A financial crisis entails a situation where the value of financial assets or institutions drops fast. A financial crisis is often linked to panic or a run on the banks where investors withdraw money from their savings account or sell off assets expecting a drop in value of those assets. It can take place following overvaluing of assets or institutions, and is usually worsened by irrational behaviours of investors. A global financial crisis involves parties to financial crisis in many nations with these parties expecting a drop in the value of their financial assets. The worst global financial crisis after the 1929 Great Depression occurred in 2008. The period between 2007 and 2009 was a critical period for finance capital in the United States and United Kingdom and to a lesser extent continental Europe. The global financial crisis led to the questioning of the viability of many banks and other financial corporations. Although the Australian finance capital escaped the crisis relatively unscathed, the global financial crisis had a negative effect on the Country’s economy. Impact of the Global Financial Crisis on the Economy of Australia Australia was a passive participant in the global financial crisis. Australia was in a well-built economic position at the onset of the global financial crisis. According to IMF (2009), the country enjoyed sound macroeconomic guidelines and structural reforms besides a stable external environment that delivered steady economic growth. A commodity price boom boosted the national income and pushed the terms of trade to its highest level. The expansion of trade reduced the level of unemployment with the Australian government eliminating its net debt and enjoyed relatively low bank and corporate leverage. However, the global financial crisis that started in 2007 and intensified with the collapse of Lehman Brothers in 2008, presented a prominent test for international architecture established to protect the global financial system stability. The Lehman Brothers failure was the biggest disaster that ever hit the United States financial industry and affected the world’s economy. The leading investment bank in the United States suffered big losses and by September 2008, the firm lost nearly 4 billion dollars in its effort to dispose its shares in one of its auxiliary firms. Impacts on Australian Markets and Australian Dollar The global financial crisis triggered by the Collapse of Lehman Brothers had an immediate effect on Australian markets and Australian dollar. The price of key commodities fell and the country’s currency depreciated. According to IMF (2009), the prices of key commodities fell sharply. The sharp fall of key commodities’ prices negatively affected the country’s economy. The fall in the prices of key commodities led to a decline in exports. Given that Australia is a commodity-exporting nation, reduced commodity prices triggered lower growth because of the decline in export income. This triggered a relatively weak growth in the country’s economy. The spread of the US financial crisis across the globe triggered a decline in the value of the Australian dollar. Between June 2008 and January 2009, the value of the Australian dollar reduced from 96 cents US to 64 cents US. This reduction in the value of the Australian dollar had numerous effects that include an increase in the country’s net foreign debt. The foreign debt increased following the call to repay more Australian dollars to attain the equivalent of the value of the foreign currency that the country had borrowed. For instance, the debt that Australia owed in US dollars in June 2008 required 50% per cent more Australian dollars to repay besides increase on the interest on debt (Strokes 2012, p.2). Strokes (2012, p.2) further asserts that the decline in the value of the Australian dollar added 84.9 billion US dollars to the Australia’s net foreign debt. Although the low value of the Australian dollar meant that the exports were profitable, the fall in price of key commodities affected the export market. Impact on the Stock/Equity Market The equity market in Australian was negatively affected by the global financial crisis. Although the stock market in Australia took long to be affected, it recorded a fall in equity prices. According to Lin, Edvinsson, Chen and Beding (2014, p.8), the Australian stock market declined by 54% during the 2008 global financial crisis. The fall in the equity prices lowered the capacity of businesses in Australian to raise new share capital. The equity prices fell at different stages because of risk aversion and heightened uncertainty. The fall of equity prices was as a result of liquidity and solvency of great number of financial institutions across the globe. Movements in the stock market have a greater effect on the economy of a nation. A collapse or fall in equity prices can cause extensive economic disruption. This is because a fall in stock or equity prices negatively affects investment. In addition, a fall in equity prices can prevent the capacity of firms to raise capital on the stock market. The fall in equity prices affects consumer confidence besides making investors hesitant to spend money in the stock market. Reduced stock prices translate to less wealth for businesses, individual investors and pension funds. According to Chen and Shi (2002, p110), the development of the stock market helps in the reduction of cost of capital accumulation. Liquidity in the stock market is beneficial to economic growth. In addition, the liquidity of the stock market makes it easy for savers to convert their securities into cash while allowing firms to secure funds through direct financing from the stock market. Evidently, the stock market holds both reactive and active relationship to the overall economy. In an active role, stock market prices affect investment and consumer spending that consequently affects the economy. Rising stock prices make it easier for businesses to finance new investments through issuing new equity stock compared to when stock are falling or low. Additionally, rising stock process inject a feeling of optimism about the future, which inspires spending that is critical to economic growth. On the contrary, falling stock prices lessens the incentive to spend and confidence in the economy. Impact on Unemployment Although the economic impact of the financial crisis was lower in Australia compared to other advanced nations, GFC negatively affected the rate of unemployment in country. According to Saunders and Wong (2011, p.299), the average rate of unemployment in OECD nations increased from 6.1 percent to 8.6 percent. In Australia, the rate of unemployment following the global financial crisis increased marginally from 4.2% to 5.2% and peaked at 6% in early 2009. The global financial crisis killed numerous jobs. According to Ferran, Moloney & Hill (2013, p.212), Australia’s rate of unemployment which stood at 4.2 % in the pre-crisis period increased to a high of 5.7% during the crisis and fell to 4.9 percent by the second quarter of 2011. Firms laid off their employees with department stores hiring fewer workers in their shops. Reduced sales implied the laying of workers in factories. However, long-term unemployment was considerably lower in Australia compared to other OECD countries. This is because scores of employers lowered working hours instead of retrenching staff. The average reduction in working hours following the crisis stood at 3.5 percent. It is important to note that unemployment affects a country’s economic growth. Unemployment strains a nation’s economy. The economic costs linked to unemployment can be measured through the loss of output and income that would have been produced by those unemployed. Evidently, unemployment represents unused human resources, which would increase a country’s GDP and living standards. Issues such as reduced business profits, the drain of government’s budget from the payment of unemployment benefits and loss of taxation impose costs in a nation’s economy. Impact on Businesses and Industries The global financial crisis affected businesses and industries. It is worth noting that businesses are the key pillars of a country’s economy. Mangioni (2008, p.277) asserts that the global financial crisis affected many business hub internationally. Major export industries located in the Australia suffered losses and so were small and medium sized businesses. Particularly, the manufacturing sector was the worst hit. The manufacturing sector accounts for a greater percentage of the Australian economy. However, during the global financial crisis, the sector was exposed to immediate and real economic fallout. The manufacturing exports fell with the greatest impact of the global financial crisis being felt by the car manufacturing industry. The automotive industry experienced a notable decrease in export and a fall in demand for local vehicles given that households and businesses limited their spending. In response to negative effects on the automotive industry, the government established tax break and stimulus measures aimed at stabilizing the car manufacturing industry in the country. This step by the government strained the country’s budget thereby affecting the economic growth of the country directly. The other sectors of the country’s economy that were worst hit besides the car manufacturing industry include the mining sector, the upper end of the real estate market, retail sales and some regional manufacturers ( Wanna, Lindquist & Vries 2015, p.104). The global financial crisis instigated contraction of the Australian economy. According to Wanna, Lindquist and Vries (2015, p.104), the country’s GDP was projected to fall by 2 percent by November 2008. Although the effects of the global financial crisis were less dramatic in Australia compared to other nations, its effects led to scores of Australian firms laying off existing working and not hiring novel workers. A number of firms went out of business. Well-known Australian service providers and retailers such as Midas, Kleenmaid, Toy Kingdom, EzyDVD and Crazy Clarks were among major business that shut down following the global financial crisis. The GFC triggered a fall in disposable income and demand for household goods. Consumers delayed purchases of luxury items and other household items an aspect that affected the GDP of the country. The country GDP fell by approximately 1.7 percent with an increase in government debt. The increased debt was partly the result of augmented government spending. It was also a result of government budget deficits resulting from the sharp declines in tax revenues and low profits as most businesses were negatively affected following the recession. Overall Effects The global financial crisis believed to be a direct result of the risk investments in the United States compelled by a combination of low interest rates, growing consumer appetite for debt, extensive utilization of securitization and loosening lending standards had great effects on the world economy. The Australian economy slowed but did not fall into recession. It is important to note that Australian economy performed better during the global financial crisis compared to other developed economies. Apparently, the GFC did not hit real activity in Australia as hard as it did to scores of other developed economies. Many factors contributed to the resilience of Australian economy during the GFC. The authorities implemented significant and timely policy response. The government introduced the decisive fiscal stimulus measures that attracted applause from the international agencies like the IMF and OECD (Saunders & Wong 2011, p.292). The country also implemented robust commodity exports to China. The rapid return to development in the Chinese economy triggered the demand for Australian mineral exports. The reforms to the labor market and strong financial regulatory blueprint increased the flexibility that cushioned the country from external shocks such as the global financial crisis. A relative low public debt and a large budget surplus also allowed the Australian government to expand its fiscal position without affecting its longer-term fiscal sustainability. Conclusion The GFC indirectly affected economic performance in most nations. Australia was a passive participant in the opening stages of the global financial crisis. The GFC began in the United States with the collapse of Lehman Brothers. The financial crisis instigated an economic turmoil that affected both developing and developing economies. Although the GFC instigated a fall in the rates of employments, key commodity prices, equity prices, the value Australian dollar and a reduction in Australian exports, the nation narrowly dodged the full effect of the GFC. Australia received minimal effects compared to other OECD nations with its GDP falling at a projected rate of 2 percent. Reference List Chen, J & Shi 2002, The evolution of the stock market in China’s transitional economy, UK: Edward Elgar Publishing. Ferran, E, Moloney, N & Hill, J 2012, The regulatory aftermath of the global financial crisis, UK: Cambridge University Press. IMF.(2009). Australia: 2009 article IV consultation: Staff report and public information notice on the executive board discussion, AU, International Monetary Fund. Lin, Y, Edvinsson, L, Chen, J & Beding, T 2013, National intellectual capital and the financial crisis in Australia, Canada, New Zealand, and the United States, UK, Springer Science & Business Media. Mangioni, V 2015, Land tax in Australia: Fiscal reform of sub-national government, UK, Routledge. Saunders, P & Wong, M 2011, ‘ The social impact of the global financial crisis in Australia’, American Journal of Social Issues, Vol.46,no.3, pp 291-309. Strokes, A 2012, ‘ Fluctuations in the value of the Australian dollar and structural change in the Australian economy’, Ecodate, vol.26, no.1, pp.2-5. Wanna, J, Lindquist, E & Vries, J 2015, The global financial crisis and its budget impacts in OECD nations: Fiscal responses and future challenges, AU, Edward Elgar Publishing. Read More