US raises interest rates

The US Central Bank, The Federal Reserve Bank, (the Fed) has raised interest rates in the US from 0.5% to 0.75%.

This may not seem like much, but for the fact this is only the second rise in ten years. (Note that 0.25% is the usual change in rates around the world.) It reflects the recovery of the US economy from the deep problems caused by 'The Great Recession' and signs that Aggregate Demand  and economic growth is picking up.

Note the factors which the Fed have cited as reasons for the rise. Clearly not everything is going really well, but AD is rising. They also seem to be taking account of the fiscal boost President-elect Trump is proposing.

Why should the Fed act now when inflation is so low (below target) and Trump has yet to unleash his 'hope for the best' economic policies on the USA and the world? The answer lies in the 'long and variable' lags in monetary policy. It will take at least 18 months for this interest rate rise to have full effect, and possibly two years. 

Another Chairman of the Fed, William McChesney Martin famously stated that the job of the Federal Reserve is "to take away the punch bowl just as the party gets going",  recognising the long lags in policy. (That is raise interest rates early in the upward part of the business cycle and not wait until inflation is already rising.)

US Federal Funds Rate December 2005 to December 2016

The Sydney Morning Herald covers the story here

This article is about monetary policy and how decisions are made. AD/AS analysis can be applied to it and analysis of why the decision has been made can be discussed.

Headline inflation down, underlying inflation up

Yesterday the June quarter inflation figures showed that the CPI in Australia was running at an annual rate of 1%. That is well below the RBA target of 2- 3% on average over the business cycle. There is a wide expectation of further interest rate cuts, if not at the August meeting of the RBA certainly by the end of the year.

The figures, which are summarized below by the ABS, do disguise a rise in underlying inflation (that is with volatile items removed) has risen to 1.5% (from 1.4%). Underlying inflation does give a better picture of what is happening in the economy, but is still very low. Indeed these are the lowest recorded inflation figures for 17 years.

The question of the next move in monetary policy is dominating the press. Many argue that the RBA must lower interest rates to boost Aggregate Demand to avoid deflation and possible recession. However others, such as former RBA Board member Professor Warwick McKibbin, argues that moving rates to near zero (or zero in Japan) did nothing to help other economies as changes in rates at such low level has no significant effect on saving and investment incentives. 

The danger of very low rates lies in reducing retirement incomes and further distorting the housing market.

The ABC cover the story here

The article is of direct relevance to VCE students who must be aware of Australian inflation movements, the influences on the figures and the monetary policy response. IB students will find this useful as an example of inflationary pressures and policy response, they should also look at the use of inflation targets and pros and cons of monetary policy in a situation of low inflation/rates where 'conventional monetary policy' is ineffective.

Australian inflation, good or bad news?

The latest inflation figures put Australian inflation at 1.7%. That's higher than economists predicted, but still quite low (the RBA target is 2 - 3%, on average, over the business cycle).

All VCE students need to be aware of the main economic data over the last four years and so it is important to follow the trends in inflation as well as unemployment, growth, the current account and government finances.

The ABC report the latest inflation figures in the article below. It notes that 'core' or 'underlying' inflation is at 2%. It is headline inflation which is at 1.7%. However like many people the ABC ignores the actual RBA target which is 2 -3% on average. It is quite possible that inflation is on target as this is a period of subdued growth during the 'downswing' of the business cycle.

Two things to note from the article.
1. Subdued growth and inflation around where you might expect in this stage of the business cycle means that interest rates are unlikely to move from their record low of 2%. There is no need to stimulate Aggregate Demand (AD), as inflation edging up suggests that AD is reasonably healthy. If it wasn't falling oil and communication prices would have caused the expected lower inflation rate.

2. Inflation can be caused by 'Demand pull' factors or 'Cost push' pressures. However it is measured by aggregating price changes over a range of different sectors. The article shows how some sectors of the economy have seen price rises, others price falls. The 'inflation' figure of 1.7% is a weighted average of the various actual price changes.

Look carefully at the data. Be prepared to follow changes in inflation and what causes it for the rest of the course.

The ABC report Australia's inflation figures here

 

Australia's core inflation rate since January 2013 

This article has direct relevance to the VCE course. However inflation is a key macroeconomic indicator which is controlled through monetary policy and so also part of the IB course.

Unemployment hits ten year high

Unemployment has risen to 6%, that's the worst it has been for ten years.

In global terms 6% isn't that high and just 3700 fewer jobs were available compared to last month. But what is really worrying is that most economies are seeing unemployment head in the opposite direction.

The charts below compare unemployment in some major economies to Australia.

 

Compared to the Euro Area, Australia is doing better, with about half the unemployment rate of that region, but the trends in the data are similar and we all know Europe is a basket case.

Compare this to the trends in the UK and USA. Unemployment is falling quickly and this is a very stark contrast to Australia. 

Of course Australia did much better than any European country and the USA after the GFC, but the current trend suggests that there is very great cause for concern. Usually developed economies see their economic fortunes move together. This is due to the strong links between economies through specialisation and trade. It would seem that Australia is not on a different economic cycle to the large developed economies.

Is there a bright side? Well Australian unemployment is still lower than the UK or USA and their growth will mean larger export markets for Australia. With fall in the value of the dollar that should help.

The Age reports the unemployment figures here