Last year, Reserve Bank governor Philip Lowe had to stare down critics who argue
ID: 1151747 • Letter: L
Question
Last year, Reserve Bank governor Philip Lowe had to stare down critics who
argued he should be slashing interest rates to boost sagging economic
activity.
Now, he's under fire for not hiking interest rates to take some heat out of the
dangerously overheated Sydney and Melbourne property markets.
But, as its latest Statement on Monetary Policy makes clear, there are solid
reasons for the Reserve Bank to ignore these calls.
In the first place, low interest rates are playing an important role in supporting
fragile consumer spending.
Although household consumption growth picked up a bit late last year, the
Reserve Bank expects this will likely prove temporary.
Instead, it believes that future rises in household spending are likely to be
modest, reflecting the weak increase in household income. What's more, high
household debt levels are likely to make consumers more tentative.
As the statement notes, surveys suggest that households' perceptions of their
personal finances have been declining since late last year, with more people
taking the view that it is better to use savings to pay off debt, rather than to
invest in real estate.
Similarly, higher interest rates would be likely to discourage private sector
investment, which is already running at low levels as a share of GDP.
Although miners are benefiting from the lift in commodity prices since the end
of 2015, the statement notes that "this has not led to a material increase in
new investment or employment in the sector, partly because the increase in
prices is not expected to be sustained".
Instead, miners have used the extra income they've received to pay down
debt, or to reward shareholders with higher dividends or share buybacks.
And the Reserve Bank appears somewhat pessimistic about the outlook for a
recovery in investment by non-mining companies.
Although there are some signs that this is occurring in NSW and Victoria,
it remains "relatively weak" in Queensland and Western Australia.
2
Indeed, the one bright spot is residential investment, which is likely to remain
high "because of low interest rates and the large pipeline of construction
projects to be worked off".
However, it notes that even this effect is wearing off and that residential
investment "will contribute less to growth in the period ahead than it did in the
recent past".
Higher interest rates would also likely push the Australian dollar higher, which
would act as a drag on sectors such as tourism and education which have
benefited from the currency's decline since 2013.
Australia's competitiveness has been boosted by the drop in the economy, it
"has helped the economy adjust to the significant reduction in income from the
terms of trade decline and the associated fall in mining investment by boosting
activity in the tradeable sector".
While soaring property prices in Sydney and Melbourne are clearly a concern,
the Reserve Bank appears cautiously optimistic that the move by banks to lift
housing interest rates, combined with the tougher stance adopted by the
regulators, will slow the demand for home loans, particularly from investors.
A major weakening in the housing market could lead to slower growth in
consumer spending which would act as a drag on overall economic activity.
Explanation / Answer
1 c) Ki rises, Ko falls
Demand for AUD increases, and, supply decreases. As the interest rate increases, foreign funds flow in.
2. c) foreign import of Australian output
Revenue is in the reserve currency; the exporter can sell these for the Australian dollar. Australian imports will increase the demand for foreign currency.
3. c) Australian purchases of shares in European organizations
Supply is generated, as, investors exchange these for the foreign currency - Euro, or, USD
4. c) the total value of exports
In the Mundell Fleming model, the exchange rate is a factor that is a determinant of net exports NX
5 c) A lower quantity of Australia's goods, and, services
The lower quantity of goods can be purchased for the same amount of money. The currency appreciates in relation to the reserve currency
6 a) unaffected as long as trade with China, and, investment in AUD is unaffected.
7 c) trade deficit increases, surplus decreases
As currency appreciates, the number of tourists & expenditure by them may decrease; this is true even for the education sector, and, the students
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