sample essay of BEO2263: Macroeconomic Analysis:

well, this is an esay unit, i thought. the assignment was essay.
Question:
Task: Whilst the world wide recession which commenced during 2007-2008 originated outside Australia, Australia cannot escape it. Briefly analyze the means by which the recession spread to Australia, and what steps Australia can take to mitigate it.

SAMPLE:
Introduction:


Many industrialized countries suffer from a deep recession which was affected by financial crisis during the period of 2007 to 2009. The global financial crisis commenced when credit risk was perceived in the general economy, especially the United States. The recession spread to the whole world, Australia is no exception. In the follow paragraphs, the analysis of the recession in Australia and the measure of decrease effect will be present.

Part A-Global financial crisis:

At the beginning of July 2007, when the investors lost faith in stock market, a liquidity crisis created the financial recession. Between 2000 and 2002, the stock bubble collapsed, which means a loss of confidence by investors in the value of securitized mortgages. Credit risk in the general economy increased and remained volatile in July 2007 and went on going up in September 2008, in which stock markets worldwide crashed and high volatility and a considerable number of banks, mortgage lenders and insurance companies failed.

The financial crisis origin in the reckless, sub-prime lending, which collapse of bubble affected the housing market showed up. Like American Enterprise Institute fellowed Peter J. Wallison, believed the roots of the crisis can be traced directly to sub-prime lending by Fannie Mae and Freddie Mac, which are government sponsored entities. On 30 September 1999, The New York Times reported that the Clinton Administration pushed for sub-prime lending: "Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people." Housing collapse caused the crisis and the financial system was vulnerable because of intricate and highly-leveraged financial contracts and operations. When the share and housing price declined, many large and well establish investment and commercial bank suffered loss even bankruptcy, and then need financial assistance.

The unemployment rate has been increasing since September 2008. For April 2009 alone, a net total of 539,000 jobs have been lost in the United States. The unemployment rate in the United States is currently at 8.9%.

A commodity bubble was created following the collapse in the housing bubble. The price of oil rose to over $140 dollars per barrel in 2008 before plunging as the financial crisis began to take hold in late 2008. A similar bubble in oil prices has preceded other historical economic contractions.

The financial crisis affected in Australia will be explained in the following part.

PART B- by which means the recession spread to Australia

In the modern world, the international trade is more and more activity. So when the economic recession was first happened in America in 2006, then it quickly speared to the other countries. Australia has also been affected by current world’s economic recession which has slowed down economic activities and financial performance during the past two years.

The spread of economic recession in Australia can be illustrated by two main aspects; they are Aggregate Demand and the exchange rate.

First of all, the effects of the unstable economic status worldwide create the negative impacts on the aggregate demand. “Aggregate demand is the total demand for final goods and services in the economy (Y) at a given time and price level. It is the amount of goods and services in the economy that will be purchased at all possible price levels. It is usually described as a linear sum of four separable demand sources:

• C is consumption demand = ac + bc(Y − T),

• I is Investment demand,

• G is Government demand,

• NX is Net export=X-M

o X is total exports, and

o M is total imports = am + bm(Y − T).

So, Y=AD=C+I+G+NX” (Wikipedia, 2009)

Consumption Demand, when there is a fluctuation on the economic condition and it getting decline, some international companies will shut down or cut their employees to reduce the cost, thus the unemployment increased, the purchasing power was depressed, and as a result the consumption demand will decrease.

Investment Demand, when the economic recession outside of Australia, the investors who intend to invest in Australia will decrease their investment. Foreign investment in Australia recorded a net inflow of $149.0 billion for the year ended 31 December 2008, a decrease of $11.0 billion on the net inflow of $160.0 billion for the previous year. (Australian Bureau of Statistics, 2008)

Second, because of the economic recession, the exchange rate fluctuated a lot during 2008. The Australian dollar grew rapidly in value up to the middle of the year, before falling sharply. By year end, the Australian dollar had fallen 21% relative to the US Dollar, 18% relative to the Euro and 2% relative to the Canadian Dollar; but had appreciated 8% relative to the British Pound and 5% relative to the New Zealand Dollar. (Australian government, 2009)

The changing of exchanging rate will cause the economic environment changed, especially in the import and export sector. And as mentioned above, the net export is the component of aggregate demand.

To sum up, because of the decrease of aggregate demand and the changing of exchange rate, the recession spread to Australia.

Part C- copes with the economic recession

When an economy falls into a depression, governments can try four things to return employment to its normal level and production to its “potential” level. Call them fiscal policy, credit policy, monetary policy, and inflation. (J. Bradford DeLong, 2009)

In this essay, two ways will discuss in details: monetary policy and fiscal policy.

Both monetary and fiscal policy are used to stabilize the economy, that is, provide the environment for sustainable economic growth with full employment and low inflation.

Monetary policy may be defined as the activities of central banks designed to influence the cost of credit with a view to achiveving low inflation and simultaneously sustainable economic growth with low unemployment. The implementation of monetary policy is the responsibility of the Reserve Bank of Australia. The Reserve Bank Act states that monetary policy must be implemented with three objectives in mind: 1, the stability of the currency. 2, the maintenance of full employment. 3, the economic welfare and prosperity of the people of Australia. Since 1996, achievement of these three objectives are seen to depend crucially on the maintenance of a low rate of inflation. The RBA therefore implements its monetary policy with a view to keeping inflation at 2 to 3 percent over the course of the business cycle. If inflation looks as if it will breach 3 percent, the RBA will act to tighten monetary policy; if inflation looks as if it will decline below 2 percent, the RBA will seek to ease monetary policy.

The chart below shows that the inflation rates of Australia fluctuate a lot since the economic recession. On October 2008, it even raised to 5%, and as mentioned above, RBA will act to tighten monetary policy to cope with the economic recession.

In Australia, as in most other countries, the major weapon of monetary policy are open or domestic market operations [OMO’s] in which the RBA engages in buying and selling government securities with a view to achieving a particular interest rate, the target rate. If the Reserve Bank wishes to tighten monetary policy, it announces its intention to enter the money market and sell securities [an open market sale]; this has the effect of debiting exchange settlement balances which puts upward pressure on the cash rate and interest rates in general.


The effect of a tightening of monetary policy can be seen with the aid of the IS-LM diagram.

Initially the economy is in equilibrium, generation an income of Y1 and an interest rate of i1: this is given by point E1. The open market sale of bonds reduces the money base and this in turn reduces the money supply. The contraction in the money supply shifts the LM curve to the left, to LM2, the interest rate rises from i1 to i2 and the level of income contracts from Y1 to Y2. The new equilibrium level of income and the interest rate are given by point E2. The level of income declines because the rise in interest rates reduces investment (and other credit sensitive) expenditures.


When the economic recession spread to Australia, RBA raised the interest to cope with it. As the figure shows from August 07 until October 08

But unfortunately, raising interest can not stop the spear of economic recession; the government had to find the other way to cope with it- fiscal policy.


Fiscal policy is aimed at regulating the level of aggregate demand by changing government receipts and/or outlays; that is, it impacts on disposable incomes. In economics, fiscal policy influences the economy by using government spending and revenue collection. (Wikipedia, 2009) It impacts on the LM curve to influence aggregate demand, fiscal policy attempts to do this by impacting on the IS curve.

Fiscal policy refers to the overall effect of the budget outcome on economic activity. It can be contrasted with the other main type of economic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. (Wikipedia, 2009) The two possible stances of fiscal policy are expansionary and contractionary.

An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through rises in government spending or a fall in taxation revenue or a combination of the two. This will lead to a larger budget deficit or a smaller budget surplus than the government previously had, or a deficit if the government previously had a balanced budget. Real government spending has grown significantly over the past decade, from $174.7 billion in 1997-98 to $264.1 billion in 2007-08, and is projected to grow to $282.1 billion by 2010-11 (see Chart 2). (Treasury, 2009)

The expansion in incomes has led to an increase in the demand for money and interest rates rise. This rise in interest rates discourages some private investment expenditure and the economy moves along the IS curve (in the direction of the arrow)
The two main instruments of fiscal policy are government spending and taxation. Changes in the level and composition of taxation and government spending can impact on Aggregate demand and the level of economic activity, the pattern of resource allocation, and the distribution of income.

Increasing the government has many benefits. For example, it can create more work opportunities. Such as when the government developed a park, it needs engineers, workers, drivers and so on. More people can get a job because of it. Further more, when these people get the job, they have the money to buy goods, so it will increase the consumption demand.

Conclusion

Whilst the world wide recession which commenced during 2007-2008 originated outside Australia, Australia cannot escape it. Because the decrease of the aggregate demand and fluctuation exchange rate, the recession spread to Australia. But there are two ways to mitigate the affection of the economic recession. One is the tighten monetary policy, the other is expansionary of fiscal policy. Using these two economic weapons, Australian has recovered from the economic recession.

Reference:

Dean Baker， The Run-Up in Home Prices: Is It Real or Is It Another Bubble?, CEPR, August 2002

Financial crisis of 2007–2009, from wikipedia, the free encyclopedia, http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008, retrieved on 2009-05-25
Global financial crisis of 2008–2009, from wikipedia, the free encyclopedia, http://en.wikipedia.org/wiki/Global_financial_crisis_of_2008%E2%80%932009, retrieved on 2009-05-25
"Greenspan Concedes Error on Regulation". New York Times. http://www.nytimes.com/2008/10/24/business/economy/24panel.html?_r=1&partner=permalink&exprod=permalink， retrieved on 2009-05-24.
Late-2000s recession, from wikipedia, the free encyclopedia, http://en.wikipedia.org/wiki/Late-2000s_recession, retrieved on 2009-05-25
Norris, Floyd (August 10, 2007), "A New Kind of Bank Run Tests Old Safeguards", The New York Times, http://www.nytimes.com/2007/08/10/business/10liquidity.html, retrieved on 2009-05-23

Aggregate Demand, 2009, http://en.wikipedia.org/wiki/Aggregate_demand, accessed at 20 May 2009

International Investment Position, Australia: Supplementary Statistics, 2008, http://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/5352.0Main%20Features22008?opendocument&tabname=Summary&prodno=5352.0&issue=2008&num=&view= accessed at 19 May 2009

Exchange rates movement, 2009, http://www.international.ac.uk/resources/43SS09_pdf.pdf, accessed at 19 May 2009

J. Bradford DeLong, Four Ways Out, 2009 http://www.project-syndicate.org/commentary/delong86/English) accessed at 21 May 2009
Australia inflation rate, 2008, http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=AUD accessed at 22 May 2009
Reserve Bank of Australia, ABOUT MONETARY POLICY, 2009, http://www.rba.gov.au/MonetaryPolicy/about_monetary_policy.html#the_implementation_of_monetary_policy

A perspective on trends in Australian Government spending, 2009, http://www.treasury.gov.au/documents/1352/PDF/03_spending_growth.pdf, accessed at 20 May 2009
Fiscal policy, http://en.wikipedia.org/wiki/Fiscal_policy, accessed at 22 May 2009