Discuss about the Effect Of Increasing Business Investment.

 

 

In this particular discussion paper, the economic scenario of Australia has been critically analysed based on interest rate decisions of the Reserve Bank of Australia. The mounting pressure of government budget deficit can be identified as one of the largest economic challenges for Turnbull government. Under the current circumstances, in order to reduce the budget deficit, Prime Minister Malcolm Turnbull has cut down the government expenditure in all fronts. As a result of the consequences, investors are reluctant to invest in the economy. In order to tackle the uncertainties of the Australian economy, the RBA has kept the benchmark interest rate to record low at 1.5 percent so that the borrowers will be encouraged to invest in the market (Letts, 2017). Precisely, the impact of the fall in the interest rate on the business investment in Australia has been elaborated in the study. At the same time, the study discusses the effect of increasing business investment due to lower interest rates on the aggregated demand curve, real GDP, and price level in the Australian economy.

During the time of economic slowdown, Central Banks of leading as well as developing economies have lowered the benchmark interest rate to boost the economy. In the meanwhile, lower benchmark interest rate policy implemented by the RBA can be considered as one of the vital aspects of Monetary Policy. In the last five years, the Reserve Bank of Australia has reduced the interest rate from 4.25 percent in 2012 to 1.5 percent in 2017 (Tradingeconomics.com, 2017). Hence, an increase in the flow of money can be evident in the Australian market due to the fall in the Bank’s interest rate. Figure 1 has been given herein below to present the last five years Interest Rate in Australia:

Figure 1: Australia Interest Rate (2012 – 2017)

Source: (Tradingeconomics.com, 2017)

Precisely, due to the lower rate of benchmark interest, borrowing will be cheaper (Catala?n, Guajardo and Hoffmaister, 2008). As a result of the consequences, both the spending and investment will increase boosting the economic progress and stability. Invariably, lower interest rate provides a smaller return from savings. Therefore, the social public tends to spend the money or invest the money rather than holding the capital (Forstater, 2016). In this way, spending, as well as investment in the market, has been increased.

Furthermore, the lower rate of interest rate encourages the consumers and business firms to take loans as borrowing costs are reduced. As a result of the scenario, spending and investments are encouraged leading to greater finance. In addition, lower interest rates contribute to the rising prices of assets such as housing. Due to asset buying, the price of housing will increase so as the consumer confidence (Heath, 2017). Thus, the consumer spending will be higher as well. Based on such aspects, it can be said that lower rate of interest implemented by the RBA will certainly encourage higher investment and spending in the Australian economy.

On the basis of the above discussion, it can be assumed that the lower interest rate will increase the business investment in Australian economy. However, the increase in business investment will have certain impact on aggregated demand curve, real Gross Domestic Product, and price level in the Australian economy. The impact of the increase in business investment on the aggregate demand, GDP and Price level has been demonstrated using the figure 2 as below:

Figure 2: Impact of increase business investment on Aggregated Demand curve, real Gross Domestic Product, and Price Level

Source: (Forstater, 2016)

Due to increase in business investment followed by lower benchmark interest rate, the money supply will be increased in the economy. For instance, the increase in business investment will increase the income of the people in Australia resulting in an increase in the purchasing power of the buyers. As a result, the aggregated demand curve will be shifted towards right side from AD to AD1 indicating an increase aggregated demand (Forstater, 2016). Convincingly, as shown in figure 1, the increase in monetary flow due to lower interest rate will cause a rise in aggregated demand. However, the aggregate supply will remain constant in the short run as there is no chance of utilisation more resources in a shorter period of time (Phan, 2014). Hence, the aggregate supply curve will remain constant at ‘AS’ as presented in the above figure.

By following the theory of demand and supply, the rise in the aggregate demand in the market due to the fall in the borrowing rate and increase in the flow of money, the aggregate price level of the product in the Australian economy is expected to increase. On the basis of figure 2, it can be seen that the shift in the aggregate demand curve from AD to AD1 leads to an increase in the aggregate price level from P1 to P2. Therefore, an increase in inflation can be evident in the Australian economy (Fender, 2012). Moreover, the rise in the aggregate demand will also lead to increase in the aggregate consumption that will further increase the real GDP of the nation. For instance, it can be seen from figure 2 that the real GDP of Australia will increase from Q1 to Q2 due to the increase in the aggregate consumption because of the rise in aggregate demand (Scott, Rabanal and Kannan, 2009). Hence, it can be clearly seen from the above illustration that the fall in the interest rate by the Reserve Bank of Australia will lead to increase in the business investment in the nation that will further increase the aggregate demand, real GDP and price level.

By considering the above analysis, it can be seen that the decision of reducing the interest rate works in the favour of the Australian economy. The fall in the interest rate will increase the flow of money in the market that will gradually increase business investment. Additionally, the increase in the business investment will increase the earning of the people and enhance the buyer’s purchasing power. Furthermore, the increase in business investment will boost up the Australian economy by increasing the aggregate demand, price level of products and services and the real GDP of the nation.

References

Catala?n, M., Guajardo, J. and Hoffmaister, A. (2008). Global aging and declining world interest rates. 4th ed. Washington, D.C.: International Monetary Fund, IMF Institute and European Dept.

Fender, J. (2012). Monetary policy. 3rd ed. Chichester, West Sussex: Wiley.

Forstater, M. (2016). Economics. 5th ed. London: A. & C. Black.

Heath, M. (2017). Australia’s interest rates aren’t as stimulatory as RBA thinks. [online] The Sydney Morning Herald. Available at: https://www.smh.com.au/business/the-economy/australias-interest-rates-arent-as-stimulatory-as-rba-thinks-20170730-gxlxjo.html [Accessed Sep. 2017].

Letts, S. (2017). RBA holds rates at record low 1.5pc, warns of high dollar risks. [online] ABC News. Available at: https://www.abc.net.au/news/2017-08-01/rba-holds-rates-at-historic-low/8763628 [Accessed Sep. 2017].

Phan, T. (2014). Output Composition of the Monetary Policy Transmission Mechanism: Is Australia Different?. Economic Record, 90(290), pp.382-399.

Scott, A., Rabanal, P. and Kannan, P. (2009). Macroeconomic Patterns and Monetary Policy in the Run-up to Asset Price Busts. 3rd ed. Washington: International Monetary Fund.

Tradingeconomics.com. (2017). Australia Interest Rate | 1990-2017 | Data | Chart | Calendar | Forecast. [online] Available at: https://tradingeconomics.com/australia/interest-rate [Accessed Sep. 2017].