Answer

BRIEFING NOTE FOR THE MINISTER

To: The Federal Treasurer

From: Monetary Policy committee

Date: 08.09.2017

Subject: Expected direction of interest rates and its impact on the economy

Purpose

The purpose of this brief is to critically assesses the Australian Bureau of Statistic (ABS) and Reserve Bank of Australia (RBA) websites data and discuss the possible direction it will take and its impact on the economy for the State of Victoria and either Western Australia or Queensland.

Issue

The domestic market shows signs of stability in inflation rates (1.9 per cent) and employments (5.6 percent) although these are happening on the backdrop of changes in the non-tradable items. Looking at the global development issues in advanced economies such as the U.S. and China, and their current fiscal policies, their effect on the local stability require critical decisions to be made. These decisions will affect the economic performance, the general population purchasing power and thus overall welfare thus a wider consultation is required.

Background

Changes in the microenvironment affect the macro environment and vice versa hence their relationship requires a careful consideration. In every country including Australia, development is propelled by the success of all areas and environment on which it operates in. These environments include political factors, economic factors, social factors, technological factors, legal factors and ecological factors. All these factors combined define the operations of an economy, directs business performance and influence the populace decisions. Capabilities of producing goods and services that meet the changing needs of the population are strongly supported by technological advancements (Obrimah, 2016; Tan & Tang, 2016). These technological advancements require investments and changes in interest rates to affect the availability of finance required for such investments. In addition, legal factors which include requirements of law, regulations, treaties or enforceability of contracts and the effect of changes in the economic environment on the impact on wildlife, oceans, and greenhouse gases cannot be overlooked.

Current Situation

A closer analysis of the Australian domestic market has the following strong indicators:

• Inflation over the recent few months has been in line with expectations indicating price stability for both production and consumption items and currently stands at 1.9 per cent.
• Consumer Price Index (CPI) inflation and measures of underlying inflation under 2 per cent which are encouraging as they are within a range which can be tamed.
• Forecasts for output growth and inflation were largely unchanged and GDP growth increased over the last few months.
• The domestic market also shows potential in growth as there has been an increase in expenditure on public infrastructure such as the pipeline which will definitely increase production and productivity (Tan & Tang, 2016).

Among key opportunities that require to be harnessed include:

• Increasing rents, providing incentive for the housing industry, decline in prices of tradable consumer durables over the year and a low inflation on food prices improving consumer welfare.
• A steady output growth expected to reach 3 per cent in the year end, increased consumption, rise in value of retail sales, rising employment and stronger household income to support the business sector.
• Stronger resource export volumes to support the mining sector, increase in exports of Liquefied petroleum gas, above average business conditions supported by the strength in commercial motor vehicles and increase in non-residential buildings approval present immense opportunities for growth.
• Improvement in the labour market with over 165,000 jobs created which enhances household income and increases spending both in consumer goods and producer goods provide an opportunity to grow the national output.

Threats to all these opportunities include:

• Increase in non-tradables inflation, increase in market services inflation since 2016 and increase in the cost of constructing new dwellings in all capital cities thus a possible decline in dwelling investment.
• Low wage growth affects consumption by reducing or hindering spending especially for households constrained with high levels of debt in weaker market conditions.
• Inability to attract workers with particular skills which have the effect of increasing wages growth more than the forecast resulting to inflationary pressures.

Therefore, strong economic conditions especially in business investment and the resilient consumption observed provide increase in inflationary pressures creating spare capacity which can be absorbed by growing economies. This shows that growth in GDP is supported by accommodative financial conditions and well organized expansionary fiscal policy as it strengthens industrial sector conditions (Elmendorf & Sheiner, 2017; Tan & Tang, 2016). Financial market condition in the global arena remains favourable and thus corporate financing to improve equity prices is possible. Among the areas that will benefit is the housing sector. House credit growth has been steady despite the steady increase in actual interest rates paid on the housing loans. This has also been happening even loan approvals for housing to investors continue to decline indicating possible growth in the future.

Conclusion

Inflation remains subdued as global economic conditions continue to improve. In the domestic market GDP growth forecast at 3 percent is expected if the interest rates remain low. This is heralded by the improved business conditions and faster growth in mining investment. In addition, strong employment growth is expected to increase household disposable income fuelling consumption growth which may be lower than the forecast due to low wage growth and high household debt. The available information and associated effects of the interest rates in the domestic market, international markets and financial markets posit a number of risks. These risks include high household debt which is exhibited in a low-inflation environment. Therefore, it will be prudent to hold the monetary policy unchanged as this is the only way we will be able to promote consistent and sustainable growth in the economy and results in the achievement of inflation that is within the target inflation over time.

Recommendations

The recommended action is maintenance of the interest rates at their current state by the monetary policy committee.

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