Quang Lam

MACROECONOMICS
INTERNAL ASSESSMENT

IB Economics Internal Assessment

School code

Name of school
United World College Maastricht

Candidate name

Quang Lam

Candidate number

Teacher

Louis Odendaal

Title of the article

Reserve Bank of Australia cuts

official cash rate to record low 2% at
May meeting

Source of the article

The Sydney Morning Herald - Mark

Mulligan

Date the article was published

5 May 2015

Date the commentary was written

15 September 2015

Word count (750 words maximum)

597 words

Section of the syllabus the article relates to Section 2: Macroeconomics

Reserve Bank of Australia cuts official cash rate to

record low 2% at May meeting
May 5, 2015 - The Sydney Morning Herald - Mark Mulligan
The Reserve Bank of Australia on Tuesday cut the cash rate to a new record low of 2
per cent, citing some ongoing economic weakness for its decision.
The widely-expected quarter-point reduction, the second in three months, takes lending
rates to the lowest point since at least the late 1950s.
The Australian dollar immediately reacted, plunging more than US0.70 to US77.88.
However, it quickly recovered to a new day's high - of US79.05 - as details emerged on
why the board voted to cut rates.
RBA governor Glenn Stevens said the decision came despite some "improved trends in
household demand over the past six months and stronger growth in employment".
However, he added: "Looking ahead, the key drag on private demand is likely to be
weakness in business capital expenditure in both the mining and non-mining sectors
over the coming year.
"Public spending is also scheduled to be subdued.

"The economy is therefore likely to be operating with a degree of spare capacity for
some time yet."
The latest round of rate cuts, which began with February's drop to 2.25 per cent, is
aimed at spurring business investment outside mining and encouraging the so-called
"animal spirits" which create jobs and drive innovation.
However, it could also further fan the flames of the hot Sydney property market and run
the risk of creating a bubble.
According to RateCity.com, Tuesday's cash rate cut will equate to home loan rates
dipping below 4 per cent this month, the lowest on record.
Peter Arnold, banking analyst at RateCity.com, said typical borrowers would save
around $1200 this year on their home loan repayments compared with what they paid
the previous year. For a lot of people in the capital cities it will be around double that.
"It's not just the RBA who's been cutting rates; the lenders have been getting in on the
action as well," he said.
ANZ was the first of the major banks to announce its response to the Reserve Bank's
cut, saying it would lower its standard variable home loan rate by 0.25 percentage
points, effective this Friday.
Tuesday's cut comes just days ahead of the RBA's quarterly statement on monetary
policy, in which the bank will detail prevailing weaknesses in the Australian economy
such as low commodity prices, the fall-off in capital investment, restraints on fiscal
spending and relatively high unemployment.
The central bank's language on Tuesday, however, appeared to suggest less of an
easing bias, meaning this might be the last cut in the current cycle.
Mr Stevens said "the inflation outlook provided the opportunity for monetary policy to be
eased further, so as to reinforce recent encouraging trends in household demand".
"This is likely to be interpreted by markets as a sign that the RBA believes it is near the
end of the easing cycle," said Australia and New Zealand Banking group chief
economist Warren Hogan.
Other commentators disagreed.

Commentary
The Reserve Bank of Australia cut the cash rate to a low record of 2 percent as a
monetary policy with the expectation to correct some ongoing economic weakness,
especially in business capital expenditure and public spendings.
Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls the supply of money, availability of money, and cost of
money or rate of interest, in order to attain growth and stability of the economy.
Monetary policy generally refers to be either expansionary policy, which aims at
increasing the money supply or contractionary policy, which aims at decreasing the
money supply. Cash rate is a term, used by Australia and New Zealand to define the
interest rate on overnight loans in the money market, which is controlled by The
Reserve Bank, which can be considered as the main monetary authority of Australia.
As mentioned in the article, the decreasing of cash rates by the Reserve Bank was an
expansionary monetary policy, which would increase the total supply of money in the
market, therefore, encourages the household and the firms to increase their
consumption and investment respectively.

G1. The effect of the decreasing of cash rates by the Reserve Bank of Australia

As shown in the graph above (G1), the increase of households consumption and firms
investment shifts the aggregate demand from AD 1 to AD2. As a consequence, the real
output shifts from Y1 to Y2, which demonstrates that the economy expanded. Therefore,
if it worked, would increase consumption, capital investment and decrease the rate of
unemployment, which Australian government recognized as prevailing weaknesses of
the economy. However, beside these advantages, average price level also shifts from P 1
to P2, which demonstrates an increase in the rate of inflation and if the Reserve Bank
did not calculate the accurate number of cash rate, it might lead to high inflation rate
which go against one of the main macroeconomic objectives of every government: to
maintain a low and stable inflation.
The decision of the Reserve Bank was risky and received mixed comments from the
specialists as some believed it would help the economy but others argued that it could
cause high rate of inflation and affect negatively the economy, including: less savings,
social unrest and if it turned worse, the bank needed to increase the cash rate, which
backfired their own policy. Still, little or no inflation would happen due to excess capacity
of unemployed labor and resources and inflation should not be a high priority in
Australia's recessionary environment. Only when consumer and investor confidence is
restored, a condition that requires low borrowing costs, will the weaknesses of
Australian economy can be resolved. Therefore, if the policy worked as the bank
expected, in the short-run, it would help the economy to increase output and
employment. But as mentioned in the article, the cash rate had been cut many times
and these cuts only showed negligible impact on real output as the economy still faced its
weaknesses. While it is acknowledged that in the long run the economy will revert back
to its original level and will have experienced increased inflation in the process.
In short, the cut would not help the Australian stagnant economy while it leaded to the
increase of inflation, even though it was not significant but still had bad impacts on the
economy which had suffered already. Therefore, instead of continuing this policy, to
resolve the issues, the government of Australia could use other solutions such as fiscal
policy - using government's taxes and expenditures to influence the economy more
directly.