QUESTION
‘An uncertain outlook for house prices and the share market and the fall in value of superannuation is causing consumers to maintain a fairly high level of household savings’ Discuss this assertion, and its implications for fiscal and monetary policy during the next 2 years.Add graphs
SOLUTION
Table of Contents
INTRODUCTION.. 2
REASONS OF UNCERTAINTY. 2
A. UNDERPERFORMING SHARE MARKET. 2
B. THE FALL IN HOUSE PRICES. 3
C. INCREASING SAVINGS. 4
LITERATURE REVIEW.. 5
MONETARY POLICY AND FISCAL POLICY COMING YEARS. 6
REFERENCES. 9
INTRODUCTION
Since 2011 beginning there is a visible instability in housing market, share market and imbalance of savings and investment rate in the economy. There are numerous examples of how these uncertainties resulted into great recession and depression in world economies such as in Japan during 1980s, in US during 2008 to till present and in European Zone now. Also there are examples that the government and the central banks play a tremendously important role in causing and controlling the turmoil. Therefore the present article aims to explain the current instability of Australian economy and implications of monetary and fiscal policy in the coming years.
REASONS OF UNCERTAINTY
A. UNDERPERFORMING SHARE MARKET
The share market in Australia has been underperforming. The reason of this underperformance can be categorized as follows:
1. Composition of the Australian share market
The Australian share market does not reflect its economy as a whole. It is dominated by REITs and mining companies which forms only 30% economy. The Australian economy is dominated by small companies which are not listed on stock exchange.
Around 40% of Australian share market is owned by foreign investor. Hence, whenever they buy or sell the Australian shares on global clues, the market faces global exposure. Thus it works based on global clues rather than based only on domestic economic fundamentals.
Global investor holding mining share of Australian share market makes their strategies considering the conditions of Chinese economy. In 2010-11 and 2011-12 the Chinese economy has gone slow and eventually it had affected the strategies of foreign investors in Australian share market.
2. Australian dollar
The strength of Australian currency lead a bi discourage for buying activities of foreign investors in local market. Rising imports, deflation and internet shopping have been the reasons of slowing retail sector of the economy.
3. Term deposit competition
The term deposits in the economy are much safer and high return investment avenue compare to the share market. This led to money drawn from share market to fixed or term deposits. This led to a fall in the share market.
4. Earnings outlook
The recent uncertainty in the dividend yield and price to earnings ratio contributed to the underperformance of the share market. The companies forecast of dividend and price to earnings ratio has been uncertain due to downfall and uncertainties in the global economies like US,UK and China.
A. THE FALL IN HOUSE PRICES
The house prices fell from 0.5% to 1% in last one year. The analysts said the housing prices depend on global events. It takes clues from the performance of European economies. The extent to which people decide to reduce their debts affects the housing prices and created an uncertainty in the housing outlook.
First National Real Estate conducted a survey to outline its Property market outlook in 2012.
The Eurozone debt crisis, strict terms of trade and inflation makes uncertain outlook of the property market.The impact of European economy and US money market at global level while at local level the impact of job insecurities, political in stability, uncertainty of future interest rates, changes in taxes etc. led the uncertainty in property market. Any cut in interest rate may boost the buying activities in the property market. Whereas any increase in interest rate will discourage the refinancing options and may result in a decline of more than 10 per cent in residential property prices.
B. INCREASING SAVINGS
The current savings of household is very high compare to the savings in last 2-3 years. Due to uncertain outlook and negative sentiments in the share market and housing market people are looking to accumulate the savings rather than making any other investment. Therefore the saving or accumulation of Superannuation savings in continuously increasing. This accumulated savings indicate the households’ debt capacity in future. As the right time arrives people will start using their savings. The increasing population will also put a demand pressure in the demand of housing market.
The below graph shows GDP growth trend in Australia which is declining in 2011.
Source : http://www.abs.gov.au
LITERATURE REVIEW
There are numerous studies explaining economic instabilities in the economies. We would discuss few of them.
Warren Brussee (2009) said that the US economy’s depression in 2008 was predicted by him in 2004 in the book “come 2008”. He predicted that the number of people taking loans will increase in 2008 that would force banks to take the houses in mortgage which will increase the supply of houses. Brussee called it housing bubble. The author also asserted that the US economy will not be normal before 2013 and it would not be fully recovered before 2020.
Now when we are standing in 2012 and Brussee’s statement seems to be true.Further he stated that the this whole circle of depression in US and then its impact on other economy started with a debt bubble in USA during 2007-08.According to him the foundation of depression was stock bubble but he called the depression of 2008 as debt depression because the debt bubble caused many other bubbles in the US economy such as housing bubble, dollar bubble and energy bubble. The increase in the age group of 30-54 caused the stock bubble. During the depression of 2008 the debt and saving rate as percent of disposable income was 135 and zero per cent respectively while this was 130 and 11 per cent in Japan during 1980s depression. Thus depression in US during 1st decade of 21st century is more severe than depression in Japan during 1980s.
The lowering of interest rate by central bank led to deprecation of dollar making imports more expensive. Expensive imports caused high inflation in the economy. The lowered interest rates also increased the demand for housing loans. More buying of houses by taking housing loans increased the supply of houses and deflation in housing prices.
Thus the lower interest rates caused debt bubble and housing bubble.
Reddy(2009) wrote in his book “India and the Global Financial Crisis’ that it is monetary policy of Reserve Bank of India which makes India stronger force to face the depression and other world turmoil than the developed economies like US and UK. The Indian banking sector has been very less affected by the global events such as recession and depressions etc. The Indian economy has been maintaining a fair balance between the globalization of it with other economies and also protecting itself from other negative happening in world economies.
Cooper (2009) made a good attempt of explaining the roles of central banks and monetary policy in creating monetary stability in an economy. The author stated that the efficient market hypothesis does not work in assets market and the stock market also should not be blindly regulated assuming efficient market hypothesis. The regulatory framework of central bank plays an important role in protecting an economy.
MONETARY POLICY AND FISCAL POLICY COMING YEARS
Monetary policy is the process of controlling the money supply in an economy. It uses different tools such as interest rates, foreign exchange rate, reserve requirements etc. Monetary policy can be categorized in two types : Contradictory and Expansionary. The Contradictory monetary policy reduces or shrinks the money supply in the economy whereas; the fiscal policy increases the money supply in the economy. The expansionary monetary policy is used to increase the unemployment during recession by lowering the interest rates. The reduced interest rates increases the demand for business investment and thereby increasing the employment and production in the economy. The contradictory policy is used to control the inflation by reducing the money supply in the economy. Money supply is reduced by increasing the interest rates .
The Reserve Bank of Australia (RBA) aims at maintaining the inflation rate of average 2-3 per cent. According to the government and the bank this is the inflation rate which does not distort economic decisions in the economy.
The below graph shows the trend of inflation over the long run in Australia
The statement of monetary policy by Governor G. Stevens has lowered the cash rate by 50 basis points, effective from May 2, 2012. The decision was taken seeing the weaker economic conditions in last few months.Growth in the world economy have been slower for last 1 year. The other world economies except Europe is on the path of recovering.
The output growth rate in Australia has been below trend over the last year. The reasons attributed by RBA for low output growth are : high exchange rate, temporary factors and structural changes in the economy due to population growth.
Unemployment rate has been at its lower side. The credit growth has been modest. The housing prices have shown some stability in 2012 after continuous decline in during 2011.
Thus to increase the output growth by increasing the corporate borrowings RBA has reduced the cash rate recently by 50 basis points.
Fiscal Policy
Fiscal policy is the process of planning the government revenues in terms of composition of taxation and government expenditure. If the government expenditure is more than government revenue it is called fiscal deficit or expansionary fiscal policy whereas, if the government revenue is more than the expenditure is called fiscal surplus or contradictory fiscal policy. The decisions of fiscal policy are affected by many other factors than only the objectives of the policy. Factors such as political instability, changes in the government , social resistance etc are the other main determinants of fiscal policy is an economy.
REFERENCES
Brussee, W. (2009). The Great Depression of debt. John Wiley & Sons, Inc., Hoboken, New Jersey.
Cooper, G.(2009). The Origin of Financial Crises: Central banks, credit bubbles and the efficient market fallacy New Age International (P) Ltd., Publishers. ISBN: 978-81-224-2560-4
Reddy, Y.V.(2009). India and the Global Financial Crisis. Orient Blackswan Private Limited.
http://www.rba.gov.au/publications/smp/index.html
http://www.abs.gov.au/ausstats/abs@.nsf/mf/5206.0
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