MORTGAGE BROKING

The Australian Economy

BY PETER ANDREWS, MBA, CPA, B.ECONOMICS, B.ARTS
Former lecturer at Macquarie University

A study of the economy is a good staring point in a course on

mortgage broking because the current state of the economy affects
matters you will be concerned with, such as movements in interest
rates and housing prices. You cannot expect to be able to make
economic predictions of your own, but ability to understand the current
state of the economy is important background to financial decision-
making.

Most people might think that the economy consists of money. Money is
what we exchange to buy goods and services and is also a system of
measurement. Printing money, however, does not create economic
wealth. Economic Editor Ross Gittins has pointed out that economic
wealth is created:
…by most of us getting up every morning and combining our labour with
Peter Andrews is a specialist trainer in
Financial Planning. materials and capital equipment to produce a bunch of goods and
services.1
After an early career in corporate finance
and banking, Peter became a lecturer at
Macquarie University. CONTENTS
He has also taught in the Graduate NATURE OF THE ECONOMY ............................................................... 2
School of Management at the University INTRODUCTION .................................................................................. 2
of Sydney and the School of Banking and
Finance at the University of New South GROSS DOMESTIC PRODUCT ................................................................. 2
Wales. SPECIALISATION IN THE AUSTRALIAN ECONOMY ....................................... 2
Peter has a Bachelor of Arts and a GROWTH OF THE AUSTRALIAN ECONOMY ........................................ 3
Bachelor of Economics from the RESERVE BANK INFLATION TARGETING ................................................... 3
University of Sydney and a Master of
Business Administration from the
FLOATING OF THE AUSTRALIAN DOLLAR .................................................. 4
University of Florida. He is also a EMPLOYMENT ................................................................................... 4
Certified Practicing Accountant
THE BUSINESS CYCLE .......................................................................... 4
THE BUSINESS CYCLE DESCRIBED ........................................................... 4
THE RESERVE BANK AND THE BUSINESS CYCLE .......................................... 5
.
INTEREST RATES AND HOUSING PRICES ................................................... 5
GOVERNMENT AND THE BUSINESS CYCLE ................................................ 6
GOVERNMENT DEBT ........................................................................... 7

1 Ross Gittins, Guide to Economics, Allen & Unwin, Sydney (2006), p.4

Copyright 2015 © Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 2 1. MORTGAGE BROKING
2
In simple societies the top priority is food production.
NATURE OF THE ECONOMY When a society is able to produce more food than it
needs and has what is called a surplus, then some
INTRODUCTION people can be freed up from food production to
Operators in the finance sector need to be aware of the specialise in producing other things. Good quality tools
changes in the economy and financial markets so that are a good example. The person who specialises in
they can affect their impact on their business and the making the tools is then able to exchange them for
interests of their client. As an example of this, the food. We call this system of exchange bartering. As a
Reserve Bank’s low interest rate policy that was evident society and its economy become more specialised and
in 2014 and 2015 made it easier to borrow for new more developed, money is introduced as the medium of
dwellings, and this stimulated the demand for housing exchange instead of the direct exchange of goods.
loans. The low variable rates, however, may put clients
at risk if interest rate rises. Mortgage brokers should With specialisation, both individuals and whole
alert clients to such a risk, and perhaps also suggest societies can become much better off. The individuals
that their clients should have at least some of their and the societies also become interdependent,
borrowings in a fixed-rate loan. providing goods and services that other individuals and
societies are willing to pay for. Both production and
The knowledge required to make such judgments and standards of living increase.
provide such advice begins with an understanding of
the Australian economy. This knowledge should be The Australian economy has both specialisation and
continuously updated with knowledge of economic interdependence. It is also a ‘mixed economy‘. That is,
change, including the affect of government policy on the government sector (federal, state and local
economic change. government) is also a major player, producing essential
community services such as health and education. In
addition, the government sector also regulates many
GROSS DOMESTIC PRODUCT activities of the private sector.
The total value of the production of a developed
economy like Australia’s is described in a statistical The four main sectors of the Australian economy are
measure called Gross Domestic Product (GDP), which is generally described as agriculture3, mining,
measured by the Australian Bureau of Statistics. A manufacturing and services (including government
continuing increase in GDP is taken to mean that services). Figure 1 shows separate output of goods and
economic output has increased and so has the standard services (GDP) for these four main sectors for 2010-11.
of living.

GDP can increase at a lower-than-expected rate and

occasionally – about once every ten years in recent
Australian experience there is a fall in GDP. If GDP falls
for two successive quarters, economists say there is a
recession, although the last Australian recession by this
definition occurred in 1991.2

Financial markets watch predictions about the future

state of the economy, and react to them. We can see
this in the share market peaks and plunges that occur
from time to time.

SPECIALISATION IN THE AUSTRALIAN

ECONOMY
It is not just the goods and services that are important.
It is the way we specialise in their production.

2
This is the Australian definition of a recession. Some other
countries consider that there has been a recession when GDP has
been negative for one quarter only. 3 Actually ‘Agriculture, forestry and fishing’.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 3 1. MORTGAGE BROKING
3
Figure 1 Figure 1
Sector Output as a Percentage of GDP, 2010-114
Agriculture Average Annual Real Growth Rate in GDP
3% Mining
7%
Manufacturing
8%
2007-13 actual 2014-19 projected

2.9% 2.8%
2.7%
2.4%

1.2% 1.3%
1.0% 1.1%

Services
0.2%
82% 0.1%

Australia USA UK Germany Japan

Notice the size of the services sector – this is a sign of a Source: IMF World Outlook Data Base. April 2014
developed economy. There has been a long-term trend
for the services sector to grow while the manufacturing The estimate of continuing sound growth for Australia is
sector declines – from around 15% in 1990 to the based on a combination of new mining projects coming
present percentage share of 8%. on stream, a residential construction boom, low
interest rates, and a growth in business investment
Australia's economy may still be dominated by the because of healthy corporate balance sheets.6 If any of
service sector, yet its economic success is based on these assumptions fail to hold, there is likely to be
abundance of agricultural and mineral resources. below-trend growth and even recession.
Mining’s contribution is increasing as new projects
come on stream and is becoming greater than the
contribution of manufacturing. It is estimated that as
RESERVE BANK INFLATION TARGETING
new mining projects come on stream mining will grow The Reserve Bank has been targeting inflation since
from its present 7% to 10% or 12% of total GDP. 5 1990, seeking to keep the long-term inflation rate
within a range of 2% to 3%. If inflation appears to be
exceeding the 3% upper limit, the Bank makes an anti-
GROWTH OF THE AUSTRALIAN inflation adjustment to monetary policy (explained
ECONOMY later).

Australia has had more than twenty years of economic The result has been a period of sustained low inflation,
growth without a recession, with GDP growing by an instead of the high inflation rates of the 1970s and
average of 3% a year during that time. This follows 1980s. Low inflation stimulates economic growth by
government economic reform measures in the 1990s lowering costs and increasing certainty.
and a period of good economic fortune in the 2000s.
The latter was caused by a combination of rising Inflation is generally measured by percentage increases
commodity prices, falling import prices and, towards in the Consumer Price Index (CPI), which is published
the end of the period, a mining capital expenditure once a quarter by the Australian Bureau of Statistics.
boom. The movement in the CPI for the 12 months to June
2014 was 3.0%, which at the top end of the Reserve
As Figure 1 indicates, Australia’s growth in GDP is still Bank’s target range.7 This is, however, is expected to
above that of most of its main trading partners, become lower when the GDP growth rate increases in
although some economists believe 2015-16.

4
Source: Year Book Australia, 2012
5 Ross Gittins, ‘The boom has bust? It's only just started’, SMH, 6 RBA Statement of Monetary Policy, August 2014.
13.10.12 7 Source: RBA.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 4 1. MORTGAGE BROKING
4
FLOATING OF THE AUSTRALIAN DOLLAR EMPLOYMENT
The Australian dollar was floated in 1983, largely Australia’s unemployment rate was 6.0% in May 2015 7,
because the system of fixing the exchange rate had up from a record low of 4.0% in February 2008. A
become unsustainable. A ‘floating currency’ is one sustained fall in unemployment is not likely until the
which has its exchange rate determined by the present downward trend in the GDP growth rate is
international currency market. reversed and, as indicated earlier, this is not likely to
happen before 2016-17.
The Australian dollar exchange rate is generally
expressed in terms of units of the United States dollar THE TERMS OF TRADE
for one Australian dollar. As such, it is the ‘price’ of the
Australian dollar, with a higher exchange rate therefore Economists focus on the ‘terms of trade’ when they are
indicating that the Australian dollar is worth more. If measuring Australia’s international trade performance.
the exchange rate increases, the Australian dollar is said The terms of trade are calculated as the ratio of export
to have ‘appreciated’. Conversely, if the exchange rate prices to import prices expressed as a percentage. To
falls it is said to have ‘depreciated’. economists, increasing terms of trade indicate
improving economic performance, with the converse
Figure 2 also applying when the terms of trade is falling.
Australia’s terms of trade have been falling since
US Dollar/Australian Dollar Exchange Rate September 2011 after a steady upward trend, as
indicated in Figure 4. The fall is consistent with the
1.20
lower growth rate in GDP, as noted earlier.
1.10

1.00 THE BUSINESS CYCLE

0.90
THE BUSINESS CYCLE DESCRIBED
0.80
Although Australia has experienced a periods of
0.70 sustained economic growth in recent years, there is still
a business cycle.
0.60

Traditionally, the business cycle has been viewed as a

regular movement between a peak, known as a boom,
and a trough, known as a recession, with interest rates
being high during the boom period and low when a
The chart in Figure 2 shows the US dollar/Australian recession has been reached. A recession is not
dollar exchange rate over the years 2010 to 2014. recognised until there have been two successive
Notice that the Australian dollar exchange rate has quarters of negative economic growth, and in terms of
been falling since mid-2013. This coincides with falls in this definition Australia escaped a recession during the
commodity prices, particularly the iron ore price. A fall Global Financial Crisis (GFC). Even so, there is still a
of this kind offsets some of the effect of a fall in discernible business cycle moving from periods of
commodity prices, but it makes imports more higher growth in output and higher interest rates, to
expensive. periods of lower growth in output and lower interest
rates.
The Australian dollar has been falling in 2015. Because
this increases export revenue, and is considered to be We can map changes in the business cycle after they
good news for manufacturers, and farmers because it have occurred by using Gross Domestic Product (GDP)
makes them more competitive on the international as a measure of economic output. The Australian
market. Minerals exporters also receive more revenue Bureau of Statistics releases GDP data once a quarter.
and the local tourist industry is assisted. This all helps to
stimulate the economy. Figure 3 shows quarterly movements in GDP for the
twenty years to June 2014.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 5 1. MORTGAGE BROKING
5
Figure 3 Monetary policy moves occur irregularly, when needed.
The RBA issues a press release explaining the decision
for any change, and indicating the intended new rate. 8
This rate is referred to as the cash rate or official rate. 9
It is important because any change to it immediately
affects other short-term interest rates, such as bank
lending rates for business and housing loans.

Movements in the cash rate from July 1994 to June

2014 are illustrated in Figure 4.

Figure 4

As seen in the chart, quarters when GDP falls (indicated

by downward ‘spikes‘ below zero in the lower part of
the chart) are rare. Australian has not had a recession –
defined in terms of at least two quarters of negative
economic growth – since June 1991. This marks
Australia from other advanced economies, which all
had a recession during the period. It also contrasts with
previous periods, when recessions occurred more
regularly in Australia,

THE RESERVE BANK AND THE BUSINESS

CYCLE
(The real cash rate is the actual rate adjusted for the rate of
One reason why there has been a long gap between inflation).
recessions is that the Reserve Bank influences economic
activity through monetary policy. Decisions on The low level of the cash rate in recent years has been
monetary policy are made at the Reserve Bank’s board consistent with low international rates and attempts to
meeting, which is held on the first Tuesday of every stimulate economic growth. As the following Reserve
month except January. Although the Reserve Bank and Bank press release of 2013 indicates, this appears to be
Treasury co-operate closely, monetary policy decisions having its intended effect:
of the Reserve Bank are made independently of the
government. ‘The easing in monetary policy --- has supported
interest-sensitive spending and asset values and further
To influence economic activity through monetary effects can be expected over time’.10
policy, the Reserve Bank targets an inflation range
between 2% and 3% a year. When inflation, as INTEREST RATES AND HOUSING PRICES
measured by the Consumer Price Index (CPI), appears
One reason why mortgage brokers should pay attention
to be pushing against that ceiling, it attempts to slow
to monetary policy is that changes in the Reserve Bank
the economy by increasing interest rates. Conversely,
cash rate have a direct impact on mortgage interest
when the economy appears to be moving towards a
rates, and this in turn has an impact on property prices.
recession, the Reserve Bank normally lowers interest
rates in order to stimulate growth. This makes money
more available and allows more spending to occur.

8 Board meeting minutes are also released in a press release two

weeks later.
9
The cash rate is the rate at which the banks are prepared to lend
to each other.
10 RBA press release, 2.July 2013.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 6 1. MORTGAGE BROKING
6
This is indicated in Figure 5, which shows the To a large extent, fiscal policy operates automatically.
relationship between the rate of growth in housing During an economic downturn, there is a fall-off in
prices and mortgage rates for the period 2001 to 2014. government revenue with lower taxation and an
To understand the graph properly, you have to note increase in government spending because of an
that the scale for changes in mortgage rates has been increase in social security payments. This is stimulatory,
inverted to ease comparison with the changes in and it can happen without any deliberate government
property prices. decision to use fiscal policy to stimulate the economy. It
is likely to be accompanied by budget deficits and
Note the close relationship between housing price rises
increased government borrowing, as has been the case
and mortgage rate falls, as is evidenced by the way the
in Australia since the GFC.
period of decreasing interest rates from 2011 onwards
has been accompanied by housing price rises.
Likewise a long period of economic growth might be
Conversely, interest rate rises have been accompanied
accompanied by increased taxation revenue and lower
by much smaller rises in housing prices and even
government spending – and hence budget surpluses.
housing price falls.
This can help stabilise the economy when it is
Figure 511 performing well because it takes some of the heat off
inflation. Australian fiscal policy was consistent with this
approach for many years until the onset of the Global
Financial Crisis. The May 2008 Australian government
budget surplus, for example, was the tenth budget
surplus in a row.

Fiscal policy that operates more or less automatically in

this way is said by economists to operate through
automatic stabilisers, the automatic stabilizers being
components of government revenue and expenditure –
such as company taxation and social security payments
– that adjust according to the business cycle in the
manner just described. It is guided, however, by what
economists refer to as the ‘fiscal stance’ of the
government.

In contrast to the operation of fiscal policy through

With this relationship in mind, the Governor of the automatic stabilisers, fiscal policy can be adopted very
Reserve Bank, Glenn Stephens, has warned that housing deliberately – as was the case during the GFC in
prices may fall if the cash rate is increased.12 That, Australia and also other countries with advanced
however, is not likely to happen before 2015-16 at the economies. The Australian government’s response to
earliest. the GFC, for example, consisted of two fiscal stimulus
packages that contained a range of measures ranging
GOVERNMENT AND THE BUSINESS from one-off payments to infrastructure spending.
CYCLE Economists refer to an approach such as this as
Traditional economics textbooks refer to the use of discretionary fiscal policy, as opposed to fiscal policy
‘fiscal policy’ as an alternative to monetary policy. Fiscal that is applied through automatic stabilisers. Compared
policy is the use of changes in government spending to monetary policy, discretionary fiscal policy has the
and taxation to either, depending on the circumstances: advantage of having an immediate impact on consumer
demand.
 stimulate the economy with a budget deficit; or
 dampen economic activity with a budget surplus.

11 Source: RBA, Statement on Monetary Policy – February 2014

12 The Australian, 4 July 2014.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 7 1. MORTGAGE BROKING
7
The fiscal stimulus packages of 2008 and 2009 GOVERNMENT DEBT
represent the first application of discretionary fiscal
policy in Australia since a fiscal package known as ‘One A feature of government budget deficits is that there is
Nation’ was introduced in February 1992 as a delayed a build-up in government debt, as has been the case
response to the recession of the early 1990s. The with Australia since 2008. For a brief period before the
normal counter-cyclical tool in Australia since the GFC, Australia – on a net basis – had zero (net)
floating of the Australian dollar in 1983 has been government debt, but the government debt level has
monetary policy (in combination with automatic fiscal been growing since. This is illustrated in Figure 7, which
stabilisers). Treasury expects that this will remain the shows government sector debt as a percentage of GDP,
case.13 with the top (blue) line indicating total debt for the
government sector as a whole.
A matter that has to be considered with discretionary
fiscal policy is that when it is applied to stimulate the Figure 7
economy it is likely to give rise to a government budget
deficit, with government spending being greater than
government revenue. As Figure 6 illustrates, this is what
happened when the Australian government applied
discretionary fiscal policy in response to the GFC in
2008 and 2009. Before that, it happened with the
introduction of the One Nation package in 1992.

Figure 6

Australia, however, is still in a much better position

than most of the developed world because of the
periods when there have been sustained government
surpluses. This is illustrated in Figure 8, which shows
government debt as a percentage of GDP for selected
advanced countries.

Figure 8
International Comparison of Government Debt as a
Periods of government budget deficits are not alarming Percentage of GDP, December 201314
in themselves provided that the government takes
steps to ensure that, on average, its budget is in surplus
250 227
during the different stages of the business cycle. This
approach, which is the traditional fiscal stance of 200
Australian governments, means that there will be some
years of budget surpluses and some years of budget 150
93 102
deficits, but on average there should be a budget 100
91
surplus through the different stages of the business
cycle. 50 20 22

-
Australia China Euro Japan United United
Area Kingdom States
13 David Gruen, Macroeconomic Group, Australian Treasury, ‘The
Return of Fiscal Policy’, address to the Australian Business
Economists Annual Forecasting Conference 2009, 8 December
2009. 14 Source: http://www.tradingeconomics.com

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615
 8 1. MORTGAGE BROKING
8
Although the Australia government debt position is still
much better than almost the entire developed world,
the Australian government is committed to returning to
a government budget surplus so that the government
debt level is reduced over time.

Copyright 2015© Mentor Education Group Pty Ltd

MB1 – The Australian Economy PA 010615