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Contents

1.

Introduction ...................................................................................................................... 2

2.

Major determinants of interest rates .............................................................................. 3


2.1

Monetary Policy......................................................................................................... 3

2.1.1Reserves bank of Australia tools for monetary policy and how they set the
interest rates ...................................................................................................................... 5

2.2

The business cycle...................................................................................................... 7

2.2.1 Unemployment ....................................................................................................... 10


2.3.2 Exchange Rates ...................................................................................................... 11
2.2.3 Economic Growth .................................................................................................. 12

2.3

Inflation .................................................................................................................... 14

2.3.1

2.4

3.

4.

Loanable fund................................................................................................... 15

Government budget................................................................................................. 18

Analysis of current Australia economic condition and interest rates forecast ......... 20
3.1

Current and forecast economic condition in Australia (Business cycle) ............ 20

3.2

Current and forecast Government budget ........................................................... 21

3.3

Current and forecast interest rate ......................................................................... 22

3.4

Current and forecast inflation rate in Australia .................................................. 23

3.5

Current and forecast Australia unemployment rate ........................................... 25

3.6

Current and forecast exchange rate in Australia ................................................. 26

Conclusion ....................................................................................................................... 28

REFERENCE LIST ............................................................................................................... 29

APPENDIX ............................................................................................................................. 35

1. Introduction
In general, the definition of the interest rate is the percent that is paid for the use of money
that has been borrowed in which the interest rate to be paid based on the percent of the total
amount loaned (Kimberly Amadeo, n.d). Interest rate can be determine by every banks in the
world, but the most common and in practice, the central banks will decide on what rate they
should put every year. In the case of Australia, the interest rate is a stagnant interest rate
where it is 2.5% since 1994. Interest rate is very important because it can affect every
consideration of the decision-making business and also peoples decisions ( McCallum,
2004). For example, buying or investing in other countries, business should take interest rate
into account as they can measure their risk of investment.
There are a few factors that determine the change of interest rate. Firstly, the federal budget
which is the statement from the Australian governments plans and conduct, and their fiscal
policy in the following financial year. Next will be the monetary policy where the control of
money supply from the central bank or in Australia the Reserve Bank of Australia (RBA).
Business cycle also one of the factors that effects the interest rate, where interest will change
during the boom or peak and recession.
Next few factors that are effect the interest rate is the inflation, where the increase of prices in
their domestic goods. Besides that, the unemployment rate is also one factors that determine
the interest rate. Finally, the growth or GDP of the country, if the GDP is great the interest
rate will be small.
This report is produced to give a brief explanation to the shareholders about what are the
major factors that determined the interest rates and furthermore to give an analysis about the
forecast of changes in the interest rates in Australia for the upcoming 12 months which is
over the 2014 to 2015 financial year.

2. Major determinants of interest rates


2.1 Monetary Policy
One of the major factors which affect interest rates is the Monetary Policy. The
monetary policy in Australia is controlled by the Reserve Bank of Australia (RBA). This
policy is used to increase interest rates to reduce consumption as well as the aggregate
expenditure. The RBA is responsible in planning and implementing the policy as well as
to manage factors such as employment rates, level of economic activity which will
maintain the level of inflation (Reserve Bank of Australia, 2014). Moreover, decisions
made through this policy affect the setting of interest rates on loanable funds in the
money market (Reserve Bank of Australia, 2014). Besides, according to Ozdemir &
Altinoz 2012, the change in the authorized interest rates which are set by the banks will
affect the money markets interest, deposits rates and lending of funds immediately.
Moreover, to influence the cash rate, the central bank can use long term securities to
impact the rates. In example, the Reserve Bank of Australia constricts monetary policy by
selling securities of the Commonwealth Government in the same time reduce the supply
of money. Thus, result in a downfall of investments and households consumption (Viney
& Philips, 2013).

The Central Bank of Australia uses this policy to form long term sustainable growth
in the Australian economy. In general when the supply of money increases, the central
bank will reduce interest rates and encourage spending. Monetary policy uses interest
rates to help control inflation by increasing and decreasing the interest rate by using
expansionary monetary policy and contractionary monetary policy.

During a recession, to encourage spending and movement in the economic activity,


the central bank of Australia will lower the interest rates to spur the economy and
encourage spending. This is because when interest rates are low, households and
businesses will demand for loanable funds due to cheaper cost of borrowing. When
households borrow, they will have more money to spend, hence an increase in
consumption which will make businesses to increase their production which also leads to
more job opportunities in the production line, thus reduce unemployment rate, people

feels richer and starts spending. Therefore by lowering the interest rates it will eventually
lead to more economic activities (Viney & Philips, 2012).

On the other hand, when inflation is above the target rate of 3, which means demand
exceeds the supply, or when a current account deficit is present. Then the Reserve Bank
of Australia will increase the rate of interest by implementing the contractionary
monetary policy to tackle this issue. Through this action taken, the Central Bank will be
able to lower down the demand for loanable funds or borrowings to discourage spending
for instance consumptions and investments. This is because when interest rates are high,
it becomes more costly for households and businesses to borrow from banks which will
result a fall in consumption and also to slow down the economic activity (Viney &
Philips). Actions taken by the central bank will lead both the demand and supply curve
back to equilibrium.

2.1.1Reserves bank of Australia tools for monetary policy and how they set the interest
rates
The effective of implementing of monetary policy is an essential tools for Reserve bank of
Australia to achieve sustainable economic growth. However inflation targeting is the main
purpose of the current monetary policy framework in Australia.
RBA has three main effective tools at its disposal to influence the monetary policy, the tools
are Open market operation, setting discount rate and setting reserve ratios.

Open Market Operations(OMO)

Open market operations are used by the Reserve Bank of Australia to handle
the monetary conditions. The central bank is given the access to handle the general
availability of the supply of funds in the money markets to preserve the overnight
cash rate stable according to the monetary policy through these operations (Viney &
Phillips, 2012). During recession, government will need funds to stimulate the
economy, RBA will buy the government securities through OMO. It is an indirectly
method to increase the money supply for government stimulate package. Moreover,
these operations can be differentiated from the Banks liquidity amenities, which are

suitable to transact with the Bank on required stipulations (Reserve Bank of Australia,
2014).

Open market operations are managed mainly by repurchase agreements,


outright or direct transactions in short-dated Commonwealth Government Securities
(CGS) as well as foreign exchange substitutes. Regarding to the determinants of
interest rates, the Reserve Bank decreases the availability of the supply of funds
within the money market through direct sales of Commonwealth Government
Securities (CGS) while additional funds are being injected from purchases. As a result
from the action taken, the overnight cash rate will have an upward pressure till a
degree set by the Reserve Bank to reach its monetary objectives due to the fall in the
money supply.
Commercial banks and other depository has a special account with the
Reserve Bank to facilitate the settlement of value transaction within the payment
system. Through the system, RBA can perform the repurchase agreement between the
depository and government. RBA is stand ready to provide a necessary liquidity by
using overnight repurchase agreement.
Likewise, the increase in the supply of money will set downward burden on
the rate of interest (Reserve Bank of Australia, 2014). Open market operations are a
role played to assists the Reserve bank to handle the monetary policy administrative
undertakings.
Discounts rates
It is interest rates that imposed to commercial banks and other depository to pay the
short term loans from RBA. The discount rates are normally lower than a Federal
Reserve funds rates. It gives more excess of the funds to the depositories and spur the
economy by lending more money to the economic Discount rates are establish by the
each Reserve bank board of directors, it is subject to view the determinations discount
rates to influences the monetary policy and it gives the rest of the market insight the
reserves plan.

Setting reserve ratio


Reserves ratio is the requirement amount of physical funds that depository institutions
are required to hold its reserves against the deposit account. It is an obligation of the
depository institutions to fulfil the daily withdrawals from the depositors. Reserves
ratio determines how much money the bank can lend out as loan and investments.
Reserve bank has to review the minimum capital adequacy requirement when setting
the reserves ratios. The reserves ratios are normally around 10% of the bank capital.
This means that if the bank has $10 billion in deposits for all its customers, the bank
can only lend $9 billion as loan and investments, and the remaining $1 billion will
kept aside to fulfil the daily withdrawals from the depositors. Therefore, RBA will set
the reserves requirement to fit the economic situations. (Viney, 2012)

2.2 The business cycle


Business cycle is defined as the pattern of the rising and descending movement in the general
level of the economic activity (Gregory, P, n.d). The business cycle consists of four stages or
points, which are the recession, trough, recovery or expansion and the peak.

The beginning stage of the business cycle is recession. This usually happens when there is
contraction in the economy which slows down the economic activity that leads to a recession.
During a recession, a negative progression will occur within the output of the economy in a
specific given time. In recession, aggregate demand will shift to the left from AD 1 to AD 2.
It is because consumer spending tends to be low because of lesser confidence in the market.
Consumers want to save in the bank rather to spend in the market, the economic activities
will decline and the real GDP will fall. During this stage, unemployment and income rate are
moving downwards. Reason to this is because when economic activity is down; consumers
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purchasing power has dropped because and also falling in wages during the recession period.
High interest rates causes the cost of borrowing is expensive, the private sector will tend to
reduce their investments and cash outflow during the recessions, it reduces the economy
activity as well.

Moreover, a recession is assumed to take place when the GDP has declined for two quarters
(Cohen & Luther, 2014). Reserve bank of Australia will try to stimulate the economic by
using its financial tool 'expansionary monetary policy' to nudge down the cash rates. When
interest is low, consumers will tend to spend more than saving in the bank. Hence, this will
promote consumer spending which then will improves the economic activity in the long run.
Besides that, the cost of borrowing will reduce due to low interest rate, the private sector will
start to borrow money and inject money to the domestic investment to create job
opportunities and income to the country. Aggregate demand will shift to the right and
produce greater GDP in the long run. Moving on, the next stage that will take place after
recession is the trough or also known as slump. However, at this stage, the GDP of an
economy is currently at its bottommost point on the business cycle.
Furthermore, the following stage after the trough is the recovery stage or also known as the
growth phase. During this stage the economy is seemed to be improving in the GDP which
will demonstrate an upward moving curve in the graph (Viney & Philips, 2012). During the
expansion stage, economy should be in the healthy condition. The unemployment rate start to
reduce and the economic activity are starting to increase. The private sectors start to gain
back the confidence and make more investments to generate cash flows. When the private
sectors inject money into the economic, due to the multiplier effect it will generate extras
8

income to the company. (Economicsonline, 2014). Besides, if the economy is managed well
by the authorities, then it is more likely that the economy will do well for the next few years.
RBA will maintain its interest rate to be low to encourage more business activities and
increase consumer spending to spur the economic growth and raise the GDP level. At this
stages. Inflation will start to increase as the consumer smoothen its level of spending.
Lastly, the final stage before the business cycle return to back to the initial first stage is the
peak stage. During this stage, the growth of the economy will be growing at a very slow pace.
This is because it has reached to the maximum point in the business cycle. In peak stages,
everything is in full employment which means all the labour resources are being use in
economic efficient way. The natural unemployment rate is maintain at 5% during peak
stages where it is an combination of frictional and structural unemployment rate that persists
is an efficient, expanding economy when labour market and resources are in equilibrium.
(Businessdictionary, 2014).Frictional unemployment is very common during peak economic,
a part of housel hold are transitioning between jobs, they are changing jobs constantly,
basically they are finding the right jobs to meet their demand. Structural unemployment is the
mismatch between the numbers of workers wants to work and the numbers of jobs available.
Moreover, the expected inflation has risen sharply due to increase in consumers spending.
Households are getting wealthy enough to spend; they are affordable for high standard of
livings in the peak economy. Lastly due to multiplier effect, the market is able to generate
more extra income to the household. It cause the level of GDP grow excessively. AD1 will
shift to the left to AD2 which closer to the full employment level of GDP.

RBA will increase its interest rate in the market to slows down the economy and also achieve
the targeting inflation rate in the long run, it discourage the people to spend. The
contractionary monetary policy also limits the consumers spending on foreign goods and

services to reduce the debts level of the country. The policy also protects the currency from
depreciation due to excessive buying foreign goods in the peak period.
When the cycle reaches this stage, it would mean that the economy will be going back to a
recession in near time to meet ends (Cohen & Luther, 2014)
2.2.1 Unemployment
Unemployment is a person classified as the labour force and wants to get a job but
have not been able to get it. Unemployment can be defined as person who unable to
get a job even though he or she is actively seeking for job. For instants, if a higher
unemployment rate happened in a country, the countrys GDP and economy will slow
down. According to McClellan, the relationship between unemployment and interest
rates can be both inverse and move together. It depends on the current economy
situation of a country. However, the usual case in Australia, when unemployment rate
increase, they will tend to lower down their interest rates. This helps the local
company to borrow more increase their productions. When production increase, they
will have to employ more workers and it will help the decrease the unemployment
rates. Besides that, the consumptions of household will increase as the cost of
borrowing is low, they will demand for more which leads to increase of production.
Adding to that, the low interest rate will also bring down the exchange rate of a
country. This means, foreign companies will tend to invest and start a business in the
country and will fight the rise of unemployment rate.
Unemployment problem which causes the level of national income and the level of
prosperity of the people do not reach their full potential is the main problem of the
macro-economic (Geoff 2012). As for, unemployment can affect a country's economy
to be slow (Linda 2013). This happens because unemployment can affect the interest
rate where the rate of unemployment can be one of the indicators used by the central
bank to decide whether to increase or decrease the interest rate (skwirk n.d). If the
unemployment rate is high, then it shows that a lot of people who do not have jobs
and do not have enough money to fulfil their needs (mike 2013). Therefore, to
increase consumer spending, the central bank makes rates to be low to improve
economic conditions. Moreover, for business, can lend with cheaper rate of interest to
help them in investing and hopefully after they invest they will increase the amount of
available jobs (Robert hall 2013). Automatically, this will certainly help to reduce the
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unemployment rate. This is shows that when unemployment is high so the interest
rates will be kept low too (Dollars & sense n.d). Otherwise, if unemployment is low,
so the level of interest will be made to be high. This happens because when the
unemployment rate in a country is low, the central bank will directly increase the
interest rate (pierre 2001). Its purpose is to slow the rate of inflation. The less the level
of unemployment means indicate that the presence of the level of prosperity and wellbeing of the country because everyone will be more work and hire.
2.3.2 Exchange Rates
Exchange rates value of a country depends on the demand and supply of
currency within the foreign exchange markets. Moreover, the demand and supply of a
currency depends on the rate of the interest of a country in relation to the other
countries (Viney & Philips, 2012). According to Reserve Bank of Australia, due to the
strengthening of the US dollar, the exchange rates of AUD has started to decline
which is doing no good to the growth of the Australian economy. However, it is still
remaining its standards in history (Reserve Bank of Australia, 2013).
The exchange rates are also able to determine the interest rates in the
economy. Rising in the interest rates might cause an increase in the worth of the
Australian dollar. Reason being, as interest rates goes up, overseas investors will be
interested to channel funds to Australian banks due to the benefits they will obtain
such as higher returns. Moreover, this will result an increasing demand to the
Australian dollar which will also lead the Australian dollar to a rise upon the
exchange rate (Viney & Philips, 2012). Furthermore, exchange rates also determine
the import and exports of goods and services within a country.
Capital flows in a country plays a big role upon influencing the exchange
rates. Investors with a big sum of money moves money around the globe on a frequent
basis. However, before investing in a country they would conjecture on the future
possibilities. Moreover, if interest rates in Australia were to drop below other
economies then the foreign investors who invested in Australia will withdraw the
funds to invest in the higher interest rate economies (Triple a learning, n.d). When
investors withdraw from Australia, this would heighten up the demand for other
countries while the AUS dollars supply would be increasing which will depreciate
the Australian currency. The diagram below explains it:
11

The diagram above shows the Australian capital outflows and the impact on the
exchange rates.
2.2.3 Economic Growth
Economic growth is also one of the major determinants of interest rates.
Economic growth generally means the upsurge competence of an economy to fulfil
the wants and needs of the people at a time. In other means, when there is economic
growth, the productivity of an economys dimension improves (Romer, P.M, 2008).
Moreover, the economic growth is measured by evaluating the Gross Domestic
Product (GDP) from year to year basis (Viney &Philips, 2012).

The illustration above is the production possibility curve (PPC) this curve
demonstrates all the productions which the economy is able to produce with the
existing resources at a given time.

12

According to Pettinger, the lower rate of interest makes it less costly to


borrow. As a result, this will encourage households and businesses to spend and
invest. Through this, it will ultimately lead to an increase in the aggregate demand
(AD) and growth in the economy. However, this may also lead to inflationary
pressures. Moving on, the expansion in aggregate demand is resulted from a number
of factors. As a rule, lower interest rates will make the cost of borrowings affordable,
which will spur economic activity through consumers, this is because, the return from
savings are much lesser which leads people to rather spend the money instead of
saving it in the bank. Moreover, cheaper borrowings will embolden firms and
households to take up loans to fund for larger consumption and venturing. Besides,
when payments on mortgage interest becomes cheaper, this will set aside more
disposable incomes for households and therefore will result in a further increase in
consumer consumption (Pettinger, T, 2013).
Overall, the interest rates will assist in increasing the aggregate demand of an
economy as well as reducing both Gross Domestic Profit (GDP) and inflation.

As shown in the diagram above, the lower interest rates will result an upward
movement in the Aggregate Demand from AD - AD2, then it will lead to an increase
in real GDP (higher rate of economic growth) and an increase in the inflation rate.

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2.3 Inflation
Inflation is defined as the presence of a sustained rise continuously in the general price level
or may also be due to a sustained decline continuously in the value of money. Meanwhile,
factors affecting the rate of inflation are spending more than normal which makes the supply
of products and services can not satisfy the supply. Therefore, with inflation rising interest
rates will affect the price and will cause people to consume less and will have an impact on
the country's economy (Econstor n.d). This is because if the rate of price increase happens it
will make the value of money will be lower and the loss of purchasing power of money.
Likewise, the interest rate can also be changed by monetary policy actions depending on
economic conditions and expected inflation (Gottfried 1960). Where, this action is used by
central banks to achieve their inflation targeting. Because when the inflation forecast is above
the predetermined targets, the central bank will use monetary policy to increase interest rates.
Which if the high interest rates mean higher cost of borrowing, thus preventing people to
borrow. This will make people to prefer to keep their money. Therefore, when people keep
more their money, it will facilitate the level of spending and aggregate demand in the
economy overall (Marcc 2011). Thus, if the rate of spending has decreased so it will balance
the production of a commodity with an excessive level of spending. Therefore, the demand
for goods and services from abroad will also decrease and slowly rising interest rates will
inhibit economic growth and it will be mislead a decrease in the rate of inflation (Marc 2011).
Meanwhile, interest rates in Australia are targeted by 2 to 3 percent. This makes the RBA will
change interest rates through monetary policy (ratedetective 2014). Because interest rates
have a relationship with the inflation so if there is inflation rate increases, the interest rate
will also increase. As for, the above statement actually also known as demand pull inflation
and cost push inflation. according, demand pull inflation occurs when increasing aggregate
demand for goods and services rather than an increase in productive capacity (Reem heakal
n.d).

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Based on the chart above stated that when the central bank increases the money then the
demand for goods and services will also increase and will result in a change from AD1 to
AD2. The demand pull inflation occurs because more money in the economy, but the goods
and services provided by the market is reduced (brieuc and Santiago n.d.) This is because the
low interest rates that make people to prefer to borrow money than saving. This can lead to
cosh push inflation.

In contrast to the demand pull inflation, inflation is illustrated by the situation in which the
supply of goods input prices caused the market to be less than usual. In the graph above
shows that a decrease in aggregate supply and shifts AS1 to AS2 because of increased
production costs. Because of the higher production costs, then the price level also increases as
shown from point A to B( Kimberly n.d)
2.3.1 Loanable fund

Loanable fund market is used to describe settings where household savings are
available to borrowers (S Priyadarshini n.d). The loanable fund typically plays a role
in terms of savings and investment processes that cause variations in the level of
income. The loanable fund is usually a good theory in charge of the savings and
investment in the long term (Education Portal nd). Meanwhile, interest rates arising in
the demand for loans, while the provision of loans available for loan. Basically the
determination of interest rates in the loan depends on the availability of the loan
amount (watch Economy 2010). Meanwhile, the availability of the loan amount is
based on certain factors such as the amount of savings made, the deposit currency, the
desire to increase the cash balance and the opportunity for capital formation
15

In the graph above shows the market for loanable fund. The blue curve above
is the demand for loanable fund or the amount of funds to be borrowed by the
company on the interest rate. In this graph, the demand curve is downward sloping
(Muddy water macro n.d). This happens due to the lower interest rate the company
can borrow money more cheaply because of the lower cost of borrowing may push
higher amount of loan while the red curve is the supply of loanable fund or the
number of individuals who want to save. This is make upward sloping supply curve.
This happens because the higher interest rate individuals get a higher return on their
money and are willing to save more (danceshoo 2013). Point where supply and
demand curves intersect is called market equilibrium. Market equilibrium is
characterized by E1. Now, at this point E1 requested loan amount exactly equal to the
quantity supplied. This means that the equilibrium interest rate there is only one store
(supply) in accordance with the desire to borrow (demand) (muddy water macros nd).
As for, there are two types of loans such as loan demand and supply of loanable fund.

16

Based on the graph above it shows that the decrease in the supply of
government budget deficit has effect of increasing the supply of savings. Where in
this graph the supply curve loan shift to the right and the interest rate decreases as a
result. As interest rates fell, the business investment and consumer spending off and
rising stock and bond markets. This makes an increase in employment, wages, and
profits so as to make the tax higher. Therefore, the deficit would shrink and
government loans will be a surplus and the supply of loanable fund will continue to
increase (Jay Kaplan nd). In essence, if the investment is greater than the interest rate
will be high and there will be savings (danceshoo 2013)

Based on the c hart above, the tax credit will appreciate new companies to borrow and
invest. This will change the investment on the interest rate and change in loan
17

demand. Instead, the tax credit will not affect the supply of loanable fund. In this case
the company has an incentive to increase investment so make loans increased and
shifted from D1 to D2. The increase in interest rates will also increase the amount of
the loan funds. Change is balanced on the above curve is represented by a movement
along the supply curve (danceshoo 2013).

2.4 Government budget


The government has several policies to carry out their duties in the fulfilment of its functions
to achieve social growth and economic growth. To implement the policies, so they have to
spend a large amount such as defence, welfare projects, development, administration and
other support operations (Gaurav Akrani 2011). Therefore, the process planning funds is
needed with sufficient income to satisfy these expenses. The planning process is called as
budget funds. Budget is an important documents that information from the government
(Gaurav Akrani 2011).
As for, in the budget presenting the government's financial plan for the period to the next
budget. But if the government of a country spends more than needed in taxes the government
can run a deficit (Kimberly Amadeo nd). When the government runs a budget deficit, mean
total government spending exceeds total tax revenue. Where their bond rating will be lowered
and they must pay higher interest to get a loan (tutor2u nd). The level of government
borrowing is an important part of fiscal policy and the management of aggregate demand in
the economy (Mark and Kenneth 2005). If the government having deficit budgets, so they
have to borrow money through the issuance of government debt such as treasury bills and
long-term government bonds (tutor2u nd).
As for, deficits have a relationship with the interest rate which if the budget deficit occurs so
it will be made government to borrow money (Leanee 1998). In this case, because of the
limited supply of money so interest rate and the price of money will increase. However, in
this case a government agency that prints money as well. So this certainly will make the
supply of money will increase and force the interest rate will be lower. In that time, the
cheapness of money will cause prices of everything will increase and will lead to high
inflation (Thomas Laubach nd). Therefore, to avoid inflation so Federal Reserve has two

18

ways in response to higher deficits. Firstly, the central bank directly purchase securities
issued by the government to finance the deficit (Edward and Jason 2004).
In addition, the second way is the private sectors also have to buy the same securities and
then the central bank will try to limit the potential rise in interest rates (Edward and Jason
2004). In this case, the government needs to create incentives for the private sector to buy
government bonds. If the purchase of the private sector does not increase then the
government would have to borrow a lot of money. Meanwhile, in a model of an open
economy, the interest rate is also affected by other macroeconomic variables. So it can be
concluded that reducing the budget deficit would not have any pressure on the interest rate of
monetary policy (Harold 1992).

19

3. Analysis of current Australia economic condition and interest rates forecast


3.1 Current and forecast economic condition in Australia (Business cycle)
As reported in THE GUARDIAN, Reserve bank of Australia (RBA) is still maintaining its
cash rates at 2.5 percent in August 2014. The governor of RBA has mentioned that the
monetary policy has done as much to stimulate the economy after the Global financial crisis.
During the GFC, government has provided large stimulus package to boost the economic
activities in Australia. Besides that, RBA has also done a lot of effort to boost the economic
activities by deciding the cut 425 basis points over the eight months from 7.25% drop to 3%
interest rate (Guardian, 2014). It is to encourage the domestic investors to make more
investment to boost the economic.

Recently, Commonwealth government has stimulus the economic by increasing the spending
over the year, RBA has collaborate with government to improve the economic activities by
maintaining the low interest rate 2.5 percent in August 2014. Certainly, the low interest had
an impact on the construction investments. (The Guardian, 2014). According to Australian
bureau of statistic, Australia annual growth rate has reach 3.5 percent 12 months to march. It
is because the increase in resources exports activities and surge constructions project has
improve the Australian GDP and the job opportunity. (Businessreview, 2014).Australias
economy is again among the fastest growing in the world.

In world economic outlook report, International Monetary Fund (IMF) has forecasted the
global economy to grow by 3.8% next year, it has resulting economic slowdown globally.
Global economic slowdown has affected the economy of Australia, despite rising of
unemployment rate 6% and the lower than expected economic growth. The mining boom
investment is getting lower, which is hurting the Australia economic growth in future.
However, rise in export resources and government stimulus package is expected to assist the
economic growth in future years. (Herald,2014).

According to International Monetary fund, Global economy slowdown affecting China


economic growth, the world fastest growing economy with growth rates averaging 10% over
20

the past 30 years. The exports in Australia may reduce due to lesser demand of primary
commodities such as iron ore and agricultural products from Asia country such as China.
(Economy watch, 2010)RBA maintain its interest rates 2.5 percent for the 14th month in a
row today, the purpose of setting low interest rate is to stimulate the domestic mining
investment to increase the real GDP (Herald, 2014)

3.2 Current and forecast Government budget


The overall GDP growth in Australia is strong, but the nominal GDP growth remains weak
due to global economic slowdowns which also affect the business activities of major trading
partner, China. It hits the exports of primary commodities such as iron ore, and the
agriculture products.

The forecast total revenue in the budget 2014-15 is $385.8 billion and the total expenditures
$412.5 billion, which means Australia, is in a deficit year. The budget deficit for 2014-15 is
now projected to be 30 billion. Government will launch the fiscal tightening which include
the welfare cuts, tax hikes and public rationalisation, and increased the infrastructure
spending (ampcapital, 2014)

According to Herald post, Government are spending lesser on health care expenditure to
reduce the burden of debt in Australia as announced in the budget 2015, it has recorded 100.8
billion spending on healthcare during 2013. In budget 2014-2015, government announced to
stimulate the economy by injecting $11.6 billion infrastructure growth packages. In Budget
2014-15, government will launch incentivising business to employ Australian who are age 50
and above through the new restart programme. With this two stimulus package, the
government expect to create more jobs opportunity to encounter the high unemployment rates
in future. The budgets also establish a sustainable sources of future productivity enhancing
road funding through the indexation of fuel excise in 2014. From this establishment,
government will reduce its spending on the fund and channel the fuel excise to the funding.
(Budget, 2014).

21

In the budget, the state government will increase the age pension to 67 by 1 July 2023, and
further increase the age pension to age of 70 by 1 July 2035. With this projection, the senior
citizens can enjoy extra cash flow in their superannuation funds and to spur the economy
activities by spending more in the future.(Budget, 2014).With budget deficit in 2014-15,
government have to borrow money from the market which cause lesser fund available for
private sector investment, and its limits the economy growth over the time. Crowding out
effect occurs during in economic recession stage.

3.3 Current and forecast interest rate


Interest rate is the tools for Reserve bank to affect the cash rate through its financial market
operation. Reserves Bank of board of directors decided and announces the cash rates after the
board of meeting. In the present day, the cash rates remains unchanged over past 10 months.
After the global financial crisis, Reserve bank reduce its interest rates from 7.25% to 2.5 %
over three years to stimulate the economic activities.(RBA, 2014) Below are the table of the
cash rates from February 2014to October 2014

Month Feb

Cash

March

April

May

June

July

August September October

2014

2014

2014

2014

2014

2014

2014

2014

2014

2.5%

2.5%

2.5%

2.5%

2.5%

2.5%

2.5%

2.5%

2.5%

rate %

In the long run, low interest rates will attract more private investors to borrow amount to do
investments. Besides that, the private consumer spending and investment will increase;
therefore the economic activity will be improved.

According to the Australian Bureau of statistic, 70% of Australian household had some
different kind of debt such as mortgage loan, vehicle loan, money owing credit cards, and
overdue bill and business debt. With 2.5 % percent of the overnight cash rate, Australian
household will enjoy the benefit of reduction in interest payment and tend to borrow more in
22

the future. Household will have extra income on the hand; it increases the consumer spending
in the Australia. Due to multiplier effect, the spending from consumer will be multiply and
increase the GDP.

On present date, the cash rates remains at the same level 2.5% where the current conditions in
Australia is slow and indulgent. Economic growth has slow down and does not meet the
expected level. The index of economic conditions fell 5.2% over the next 12 months.
(Reuters, 2014) The rising of unemployment rate has reach 6% in this year and low interest
may encourage more domestic investment and create more job opportunities. Furthermore,
the Australian dollar has been depreciating in values over the months, due to low interest
rates 2.5%. In July, Australian dollar has drop 8 % in value against U.S dollar. (Evans. M
2014). Weaker Australian economy could even further cash rates cuts by RBA. Lower
interest rates means lower in Australia. Investors will rather invest in other country, and then
it reduces the attractiveness of the currency. In other hand, Australia export goods will be
affordable to the overseas buyers.
3.4 Current and forecast inflation rate in Australia
Form the above, it is already been mentioned that Reserved Bank Of Australia (RBA) stated
that they want to keep their inflation rate in between 2% to 3% over their economic cycle in a
year (Reserve Bank of Australia 2014) . It is a very important that the decision making of
monetary policy to achieve their targeted inflation rate every year. Besides that, inflation rate
is also one of the key determinants of the change of interest rates.
Types of inflation policy that central bank are using it is inflationary pressures or the inflation
plus targeting. Inflationary pressures are likely reducing when the aggregate demand in the
economy is diminishing. Monetary policy can be improved which will give short term
motivation to the economic activity (Reserve Bank of Australia 2013). However, inflation
plus targeting, the Banks policy strategy has been reanalysed its inflation targeting
background to include indefinite factors such as medium term risks and in addition
lengthening the time frame of risk assessment (Bell 2004). As the price of credit has reduced,
borrowers have made an effort to increase their gearing on the demand side (Bell 2004).

23

As shown in the graph above, it is shown clearly that their inflation target of 2-3% started at
1990s. RBA will consistently take some steps to ensure the inflation rate is within the range.
For example, during the 1980s, the inflation rate in Australia went up to 10.5% then RBA
takes the step by using monetary policy to slow down the economics of Australia and the
inflation rate constant at the range of 2-3%. However, the current inflation rate which been
recorded as at June 2014, the inflation rate was 3.0% (Reserve Bank of Australia 2014.
Besides that, the inflation rate for the past three quarters was significantly ups and down. This
may due to the increase of exchange rate where all imported goods are much expensive than
previous years. The inflation rate of 3.2% happened due to the
When it comes to analysis the relationship between cash rate and inflation rate, there will be a
few news that can be consider in inflation. According to RBA, they expect that the inflation
rate will be stable in the next three quarters of 2014/2015 (Reserve Bank Australia 2014).
They expected the average inflation rate for 2014/2015 will be 2-3 percent. According to
The Australian news report, it stated that inflation will drop in between 1.75 per cent to
2.75 per cent, down from its previous estimate of 2.25 per cent to 3.25 per cent. They
mentioned that, the stable inflation rate can be achieved with the help of stable interest rate,
domestic economy and their exports activities (The Australian 2014).
Besides that, the central bank (RBA) also mentioned that the fiscal or the government budget
will also affect the inflation rate. When interest rate increased by the banks, people will tend
to save more as it is more profitable to them and more expensive for them to borrow. With
this, the inflation rate will reduce to their targeted inflation rate. Vice versa, if federal

24

government want to pump in more money to the banks, banks will lower their interest rates,
and people will tend to borrow more which leads to increase the spending power of
individuals. This will lead more demands of goods and limited supply which leads to increase
of price and inflation.
The inflation rate in Australia can clearly been seen that, every year, RBA will try to
implement monetary to control their cash rate, interest rates and their inflationary gap. This to
ensure that every move for their policy will improve their economy conditions.

3.5 Current and forecast Australia unemployment rate


Unemployment rate is also one of the factors that can determine the interest rate of Australia.
According to ABS, unemployment happen in Australia every year due to the separated
from their existing job either by retrenched or resigning. Besides that, the unemployment rate
also increase due to the flows between unemployment and outside the labour force, such as
individual start or stop searching for work. Besides, in Australia there are major factor of
unemployment such as frictional, structural and cyclical unemployment.
In Australia, the unemployment rate measures the number of people actively looking for a job
as a percentage of the labour force (Trading Economics 2014). On December 2013, the
unemployment rate was recorded 5.8% which is within their target. However, in 2014 the
unemployment rates have been increasing and decreasing from 5.8% to 6% then dropped to
5.9%. Surprisingly, the unemployment rate in Australia reached their peak at 6.1% as at
October 2014. This shows that the number of jobs fall by 30,000. Besides, Australia also fails
to increase their part time jobs as there are fall approximate 50,00 part time jobs. However,
they managed to increase the number of full time jobs by 20,000 workers within the quarters.
The rise of unemployment rate in Australia may due to the current economic situation this
year. It was also stated that, the unemployment rate for Australia set to be the second worst in
Asia Pacific (The Guardian 2014). Besides that, according to ABS, there are numbers of part
time workers claiming that they are not employ which lead to the increase number of
unemployment rate in Australia.
Next, According to International Monetary Fund (IMF), the unemployment for Australia is
one of the worst since 2012. Besides, The IMF expects Australia to grow 2.8% in 2014 and
25

2.9% in 2015. However, it is still below its long-term average of about 3.25% and this level
will not help much with the unemployment rate in Australia. Based on the news, Mr Kennedy
expects the unemployment rate will peak at 6.2 per cent or 6.3 per cent till the end of the year
or continue until next year for the next three quarters.
Adding to that, Oliver Blanchard the chief of IMF said that, if Australia keeps the low interest
rates remains for the next few years, it will be a risk to the Australian economy especially the
unemployment rate. This shows that, the relationship between interest rates and
unemployment rate is very crucial for the Australian future economy.

3.6 Current and forecast exchange rate in Australia


Exchange rate is the price of countrys currency in other currency. This involve in two
components which are the domestic currency and the foreign currency. In this report, we go
to compare the exchange rate with the country Malaysia. Refereeing to the exchange rate
history between Malaysia and Australia, in the third quarter of the year 2014 the exchange
rate between this two country was RM 2.85 for 1$ as at 14th October 2014 (XE.com, 2014).
This rate is a low rate since 2010.
There are few factors that can affect the exchange rate of a country which are the inflation
rate, interest rate, public debt, terms and trade and political stability. It is clear that, interest
rate have a relationship with the exchange rate of a country. In Australia, it remains at 2.5%
for the past 14 months since 2013 (News.com, 2014). Interest rate is one of the key
determinants to determine the exchange rate of Australia. When the interest rate s lower,
individuals or companies will tend to deposits more money at overseas banks as it is more
attractive. Because of this, the demand for Australian money will increase as there will be a
higher rate of return for the depositors. A higher interest rate will tend to appreciate the
exchange rate. But for Australia, the interest rates remain the 2.5% for the past 14 months and
it didnt fluctuate the exchange drastically. The minimum exchange rate that Malaysians have
to pay for is RM 2.6 for every Australian dollar while maximum rate that they reached was
RM 3.82 in year 2011. It is clear that; interest rate is not one of the major that determined the
exchange rate of Australia because the interest rate was stagnant for a long period.
Based on the AUD news, it is been stated that the exchange rate for Australian dollars and
American dollar will remain stagnant as the imports and exports of China is higher than their
26

forecast. People will tend to invest and buy more from China as it is more profitable and
cheaper for other countries. This may the reason why is the exchange rate for Australia
depreciated at this moment. Adding to that, in the other news of Wall Street Journal, it stated
that appreciate of Yuen currency for 7 months high will slowdown the economy transaction
in the world (Trivedi, 2014).
However, an economist predicts that the Australian exchange rate will remain strong in 2015
if the RBA do something with the monetary activities. This is because; he said that the
Australian money is still over valued which give them the strength to keep their exchange
rate high. The Australian dollar next move will really depends on the health of Chinese
economy, Australia economy and also and whether the US will stick to its plan of letting
interest rates rise (Evans 2014)
If the Australian bank wants to control the exchange rate to be stronger, they should increase
the interest rates as it will attract more investors in as they will have more benefits to it. If the
interest rate increases, investors from foreign company will tend to start their business in
Australia. With this opportunity, they can also decrease the rate of unemployment as there
will be new job opportunity for the Australians. Adding to this, they also able to control the
inflation rate as people get jobs and their spending power has already increased.

27

4. Conclusion
By referring the analysis above, we can conclude the major determinant of interest rates are
the unemployment rate, business cycle, federal budget, monetary policy, economic growth
and exchange rates. All the analysis above has showed that all the factors are closely linked
to each others.
The international monetary fund (IMF) on 7 Oct 2014 has downgraded its outlook for the
global economic growth in 2015 due to broad slowdown in several emerging market such as
China, Euro zone and United States. (Talley.I, 2014). IMF has said that it expected to grow
by 3.8% and causes the stocks to drop to 1% in Australia (Guardian,2014). According to
The Australian news report, economic experts stated that inflation will drop in between
1.75 per cent to 2.75 per cent, down from its previous estimate of 2.25 per cent to 3.25 per
cent. RBA has maintain its interest rates to 2.5% over 14 consecutive months, RBA thinks
that the low interest rate could not stimulate the economic at the moment due to low
consumer confidence and forecasted a revised down growth for next year. (Guardian 2014).
Moreover, IMF has forecast Australia will be the second worst unemployment rate among all
the Asia countries in coming years.
RBA has set low interest rates in Australia attracted large number contractions project to be
launch in coming years and boost the economy activities. Australian dollar will appreciation
in value will depend on the health of China economy, Australian economy, and Federal
Reserves interest rates coming years. According to Yahoo finance, the interest rates remains
unchanged at this moment but expert has forecast the interest rate will rise over next 12
months to tighten the borrowing of the household. (Hernandez.V 2014) . In order to rebalance
the economic growth, RBA may increase the cash rate over the next 12 months.

28

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APPENDIX

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