Youth Dividened Article RBA
Government policy in Australia regarding the latest change in the Cash rate by the RBA and its effects on the CFM and whether this decision was a good or bad one amidst the current battles with inflation?
As of December 11 2024, the Reserve Bank of Australia (RBA) has decided it will maintain the cash rate at 4.35% and Exchange Settlement balances at 4.25%, making no adjustment to the current monetary policy position. On the other hand, interest rates have been raised by four percent since May 2022 to return inflation (currently 3.9%) over the June quarter within the target range of between 2–3%. Headline inflation has temporarily been brought down to 2.7% in August because of temporary cost of living relief stimulus packages from the government, which, however, cannot be seen to continue after this stimulus fades and inflation will probably stay above target.
Between 2021 and 2024, there were notable fluctuations in the household consumption, disposable income, and saving ratio within Australia. Disposable income growth reached its peak of almost 8% in 2021, while consumption greatly suffered going down close to -10% as result of COVID-19’s effect on economic recession. In that period, too, the saving ratio surged to around 14%, wherein households tried to amass savings in case something went off kilter economically. By 2022, growth in disposable income reached 0% an 8% decrease since 2021 and consumption had fallen to around 3% a 13%. Decrease after reaching its peak in mid 2021 at 16%, indicating fiscal support was coming to an end and that inflationary pressures were building. Correspondingly, the saving ratio fell significantly, from 14% to about 8%, a decline of 6%, as households drew on savings to sustain spending. In 2023 and early 2024, the saving ratio continued to decline, falling back toward pre-pandemic lows of around 2%, while growth in disposable income and consumption continued to fluctuate following the economy’s unstable state. The circular flow model is changed significantly by fluctuations within the household saving, consumption, and disposable income. Altering the flow of income, spending, and production between households, businesses, government, and financial sectors.
On the other hand, business investment as a share of nominal GDP has seen a moderate recovery from near historic lows in Australia between 2021 and 2024. Throughout 2021, investment has hovered around 11% of GDP, as businesses exercised caution given the effects of the pandemic still remaining and low business confidence amid uncertain sales prospects. At this point, weak consumer demand and unpredictable market conditions likely kept businesses from committing to substantial new investments. By mid-2022, business confidence was improving with economic recovery, and investment rose somewhat to more than 12% of GDP a 1% increase from its low in 2021, which suggests that businesses were anticipating stronger sales and began investing in capital projects to position themselves for future demand and increased business confidence from the households. However, levels of investment were very far below the over 18% peaks reached in 2012 as companies faced higher costs and persistent economic uncertainties. The investment continued to grow in 2023 and 2024, settling steadily around 12-13%, another 1% increase reflecting cautious optimism, constrained by cost pressures and cautious forecasts of sales growth. Fluctuation in business investment has a spiral effect on the circular flow of income in terms of production, employment, household incomes, and consumption, reflecting general economic conditions, confidence levels, and all cost related constraints that prevail at any given period.
Additionally, Australia’s trade data reflects strong export growth and a positive trade balance from 2021 to 2024. During the year 2023, exports were at approximately 25% of nominal GDP, while imports were at around 20%, thereby resulting in a significant trade surplus. The trend is that the major industries, such as mining or agriculture, were performing well and helped to provide such export growth. The quarterly fluctuation of trade value, from a high of 18.2K million AUD in May 2022 down to about 5.4K million AUD as of mid-2024 a 12.8k million AUD decrease, reflecting shifts in global demand, supply chain and trade restriction problems due to current ongoing conflicts and other political events effecting production and trade. Another key trend with regards to trade with fossil fuels like coal are, they are starting to decline as a result of the world’s effort to start initiatives for renewable energy to combat against the pressing hands of climate change due to this there has been an 11% decrease in trade for coal. According to the circular flow model, this export surplus adds to national income as money from international trade trickles back into Australian businesses. These inflows are conducive to higher investment and consumption levels, therefore stimulating economic growth through growth in the level of household income, business profits, and government revenue brought about by such economic activity.
Household living standards are affected both positively and negatively affected by the RBA’s decision to hold the cash rate at 4.35%. Benefits include, steady rates avoiding an increase in borrowing costs which may help households in handling loans or debt repayments and keeping disposable income more stable. This is beneficial for sustaining household’s purchasing power in the short run amidst such high living costs. The main cost is that inflation still remains above the target which erodes real purchasing power and must be continually factored into decision making. Similarly, lower yields on savings discourages saving behaviour by households, which is detrimental to financial security in the long term.
In the short term, holding the cash rate will lead to stable loan repayments and financial predictability supporting households. Additionally, the disposable income will stay the same maintaining consumption required to uphold living standards in the high inflation environment. Though in the long term, unless wage growth runs higher than inflation, households could struggle with decreased purchasing power, leading to households drawing on savings or taking on extra debt to finance standards of living, which would make households increasingly financially vulnerable over time.
The decision to hold rates through the Circular Flow Model supports the household spending flows, benefiting businesses with continued consumption and factors of production. Conversely, persistent inflation within an AD-AS model perspective reduces the real purchasing power of the households over the long term. This is shown through a leftward shift in the aggregate demand curve because of weakening consumption, in conjunction the aggregate supply curve will also shift left as a result in lessened demand.
For economic growth, the decision to hold the cash rate has both advantages and disadvantages. One of the primary benefits of holding rates within an economy is that it allows businesses to budget for the costs of borrowing more effectively, thereby giving them the confidence to invest and expand. In fact, this stability ultimately allows businesses to formulate financial plans without the threat of unexpected interest rate increases that might spur productivity and expansion. However, one of the significant negative consequences is the risk of persistent inflation that could increase the price of inputs to businesses and may squeeze profit margins for those who cannot pass on these costs to consumers.
Stable rates in the short run make for a very good environment for businesses to grow, encouraging investment in capital and, possibly, increased employment, this can enhance business confidence, which is a necessary ingredient for economic recovery and growth. But in the long run inflationary pressures could start to build up, these rising costs could squeeze businesses and make investors more cautious. Long term sustained inflation may also dampen consumer demand with implications for revenue levels in discretionary spending based industries.
From the perspective of the Circular Flow Model, stable rates facilitate spending and investment flows, which stimulate economic activities and support growth. According to the AD-AS Model, high inflation will eventually shift the aggregate demand curve left as the purchasing power of consumers falls, leading to decreased investment and slower growth, additionally aggregate supply will alsoshift left because of a decrease in demand in the long run. Overall, even though rate stability is supportive of short term growth, the absence of checked inflation may undermine its benefits over time and requires a balanced approach to maintain sustainable economic expansion.
Going forward, the RBA would have to play with its monetary policy, balancing it in a way that economic stability is sustained, while keeping the pressures of inflation at bay. With inflation above target and fiscal support being retracted, economic growth trends beyond the immediate near term would, therefore, be dependent on household consumption patterns, business investment, conditions in the labour market, and global economic trends.
Still consumption remains a critical driver of overall economic activity. High interest rates and the eroding of real wages continue to dampen this important sector, although stable cash rates have undoubtedly brought a degree of comfort from the viewpoint of debt servicing. High inflation, however, erodes disposable income at a fast clip, hence reducing households’ purchasing power. Unless wage growth is above inflation, households may have to cut discretionary spending, which will lead to lower consumption growth. This could have large implications for industries dependent on consumer spending, such as retail and hospitality.
Besides, the household saving ratio has declined to almost pre-pandemic levels to indicate that most households have already drawn down their financial buffers. With the savings depleted, it will be rather hard for an increasing share of the population to absorb further economic setbacks such as unexpected job losses or global economic downturns. This, in turn, enhances the vulnerability to defaults on mortgages and other debt obligations, with potential spill over to the stability of the financial sector.
The labour market, on the other hand, has been more resilient so far, given the economic uncertainty. However, labour market conditions are likely to deteriorate should inflation be sustained and real wages lag further. Businesses will review their hiring practices in response to higher costs and weaker consumer demand, which would then lead to unemployment and increased job insecurity, further depressing household confidence and spending.
On the business side, investment levels have improved modestly but remain well below historical highs. Many firms are still cautious about committing to large-scale capital expenditures amidst uncertainty over inflation, interest rates, and global economic conditions. Higher input costs and supply chain disruptions, fomented by geopolitical tensions, continue to be a challenge for businesses looking to expand. Besides this, with the cost of borrowing so high, firms that leverage credit to fund expansion will be reining in their investment plans, thus possibly slowing productivity and job gains.
Maybe one of the most paramount considerations touches on how monetary policy will continue to impact small and medium enterprises. These are rather sensitive to interest rate changes since their operations and cash flow management heavily rely on financing. In any case, maintaining the cash rate at 4.35% is likely to bring about higher costs of borrowing to SMEs. This could negatively impact the opportunity of SMEs to invest more in expansion, innovation, and hiring, contributing to employment growth and overall economic growth, in which they also play a pivotal role.
Looking at the external position, the trade position continues to look somewhat decent with consistently strong trade surpluses assisted by strong exports in the key sectors of mining and agriculture. Nevertheless, shifts in global demand-including but not limited to the transition toward renewable energy-could affect the reliance of the country on fossil fuel exports. For example, the decline in coal trade shows that the emphasis is shifting toward cleaner sources of energy and could thus impose certain structural changes in the Australian economy. Export diversification and investment in growth sectors are paramount if the country is to achieve sustainability of long-term trade growth and economic resilience.
Government policy will also be an important determinant of economic outcomes. Monetary policy will determine inflation and borrowing costs, but there are fiscal policy measures that can be applied to offset some of the negative impacts of high inflation and interest rates, including targeted stimulus, infrastructure spending, and social support programs. As the effects of past stimulus packages wear off, the government may have to consider further measures to support vulnerable households and businesses, especially if economic conditions deteriorate.
The interest in the housing market also remains, with higher interest rates dampening the property price growth and reducing housing affordability. While a stable cash rate may provide some relief to borrowers, housing affordability concerns persist, more so among first-time buyers. If rates remain high for a longer period, mortgage stress can increase among highly leveraged households and increase the risk of defaults, with downward pressure on property prices.
From a macroeconomic perspective, the interplay between monetary policy, inflation, and growth is still fragile. If inflation does not fall, the RBA may be compelled to increase rates once again, further depressing economic growth. If, however, inflation improves but growth slows down significantly, the RBA might cut rates to spur demand and investment. And it is in finding the right balance that economic stability will be ensured without allowing long-term inflationary pressures to set in.
It will also be necessary to keep in mind the general global economic environment within which Australia is supposed to move economically. Slowing growth in major trading partners, ongoing geopolitical tensions, and supply chain disruptions may knock on export demand and general economic performance. Fluctuations in commodity prices, exchange rates, and foreign investment flows will also affect the economy.
Meanwhile, while this decision of the RBA offers short-term stability by keeping the cash rate at 4.35%, it does not fix the fundamental challenges besetting the Australian economy, such as inflation-hit households whose purchasing power is being eroded, businesses operating in uncertainty over investment decisions, and global economic risks. Looking ahead, what will be called for is a prudent monetary policy underpinned by selective fiscal actions in order to negotiate these challenges and underpin sustainable economic growth over the coming years.
Overall, in the current economic setting, the positives of setting the cash rate outweigh the negatives. In a period of steady borrowing costs, the RBA is assisting households to service the existing debt with sustainable disposable incomes, supportive of short run consumption and in general, living standards. For businesses, steady rates mean reduced uncertainty, which encourages investment and, in turn, promotes growth as consumer demand stays steadfast. While the cost of such a decision would be sustained inflation eroding purchasing power, the RBA approach allows for cautious economic recovery without immediately increasing financial strain on either households or businesses. In that respect, while inflation control is relevant for longer term stability, the decision to leave rates steady strikes a positive balance between the needs of supporting current economic activity and providing flexibility to address inflation in the future, should it be necessary.
