MORTGAGE BROKING
The Australian Economy
BY PETER ANDREWS, MBA, CPA, B.ECONOMICS, B.ARTS
Former lecturer at Macquarie University
Peter Andrews is a specialist trainer in
Financial Planning.
After an early career in corporate finance
and banking, Peter became a lecturer at
Macquarie University.
He has also taught in the Graduate
School of Management at the University
of Sydney and the School of Banking and
Finance at the University of New South
Wales.
Peter has a Bachelor of Arts and a
Bachelor of Economics from the
University of Sydney and a Master of
Business Administration from the
University of Florida. He is also a
Certified Practicing Accountant
.
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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
materials and capital equipment to produce a bunch of goods and
services.1
CONTENTS
NATURE OF THE ECONOMY ............................................................... 2
INTRODUCTION .................................................................................. 2
GROSS DOMESTIC PRODUCT ................................................................. 2
SPECIALISATION IN THE AUSTRALIAN ECONOMY ....................................... 2
GROWTH OF THE AUSTRALIAN ECONOMY ........................................ 3
RESERVE BANK INFLATION TARGETING ................................................... 3
FLOATING OF THE AUSTRALIAN DOLLAR .................................................. 4
EMPLOYMENT ................................................................................... 4
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
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NATURE OF THE ECONOMY
INTRODUCTION
Operators in the finance sector need to be aware of the
changes in the economy and financial markets so that
they can affect their impact on their business and the
interests of their client. As an example of this, the
Reserve Bank’s low interest rate policy that was evident
in 2014 and 2015 made it easier to borrow for new
dwellings, and this stimulated the demand for housing
loans. The low variable rates, however, may put clients
at risk if interest rate rises. Mortgage brokers should
alert clients to such a risk, and perhaps also suggest
that their clients should have at least some of their
borrowings in a fixed-rate loan.
The knowledge required to make such judgments and
provide such advice begins with an understanding of
the Australian economy. This knowledge should be
continuously updated with knowledge of economic
change, including the affect of government policy on
economic change.
GROSS DOMESTIC PRODUCT
The total value of the production of a developed
economy like Australia’s is described in a statistical
measure called Gross Domestic Product (GDP), which is
measured by the Australian Bureau of Statistics. A
continuing increase in GDP is taken to mean that
economic output has increased and so has the standard
of living.
In simple societies the top priority is food production.
When a society is able to produce more food than it
needs and has what is called a surplus, then some
people can be freed up from food production to
specialise in producing other things. Good quality tools
are a good example. The person who specialises in
making the tools is then able to exchange them for
food. We call this system of exchange bartering. As a
society and its economy become more specialised and
more developed, money is introduced as the medium of
exchange instead of the direct exchange of goods.
With specialisation, both individuals and whole
societies can become much better off. The individuals
and the societies also become interdependent,
providing goods and services that other individuals and
societies are willing to pay for. Both production and
standards of living increase.
The Australian economy has both specialisation and
interdependence. It is also a ‘mixed economy‘. That is,
the government sector (federal, state and local
government) is also a major player, producing essential
community services such as health and education. In
addition, the government sector also regulates many
activities of the private sector.
The four main sectors of the Australian economy are
generally described as agriculture3, mining,
manufacturing and services (including government
services). Figure 1 shows separate output of goods and
services (GDP) for these four main sectors for 2010-11.

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’.

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Figure 1
Sector Output as a Percentage of GDP, 2010-114
Agriculture
3%
Services
82%
Notice the size of the services sector – this is a sign of a
developed economy. There has been a long-term trend
for the services sector to grow while the manufacturing
sector declines – from around 15% in 1990 to the
present percentage share of 8%.
Australia's economy may still be dominated by the
service sector, yet its economic success is based on
abundance of agricultural and mineral resources.
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
new mining projects come on stream mining will grow
from its present 7% to 10% or 12% of total GDP. 5
GROWTH OF THE AUSTRALIAN
ECONOMY
Australia has had more than twenty years of economic
growth without a recession, with GDP growing by an
average of 3% a year during that time. This follows
government economic reform measures in the 1990s
and a period of good economic fortune in the 2000s.
The latter was caused by a combination of rising
commodity prices, falling import prices and, towards
the end of the period, a mining capital expenditure
boom.
As Figure 1 indicates, Australia’s growth in GDP is still
above that of most of its main trading partners,
although some economists believe
4
Source: Year Book Australia, 2012
5 Ross Gittins, ‘The boom has bust? It's only just started’, SMH,
13.10.12
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Figure 1
Average Annual Real Growth Rate in GDP
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%
0.2%
0.1%
Australia USA UK Germany Japan
Source: IMF World Outlook Data Base. April 2014
The estimate of continuing sound growth for Australia is
based on a combination of new mining projects coming
on stream, a residential construction boom, low
interest rates, and a growth in business investment
because of healthy corporate balance sheets.6 If any of
these assumptions fail to hold, there is likely to be
below-trend growth and even recession.
RESERVE BANK INFLATION TARGETING
The Reserve Bank has been targeting inflation since
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-
inflation adjustment to monetary policy (explained
later).
The result has been a period of sustained low inflation,
instead of the high inflation rates of the 1970s and
1980s. Low inflation stimulates economic growth by
lowering costs and increasing certainty.
Inflation is generally measured by percentage increases
in the Consumer Price Index (CPI), which is published
once a quarter by the Australian Bureau of Statistics.
The movement in the CPI for the 12 months to June
2014 was 3.0%, which at the top end of the Reserve
Bank’s target range.7 This is, however, is expected to
become lower when the GDP growth rate increases in
2015-16.
6 RBA Statement of Monetary Policy, August 2014.
7 Source: RBA.
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FLOATING OF THE AUSTRALIAN DOLLAR
The Australian dollar was floated in 1983, largely
because the system of fixing the exchange rate had
become unsustainable. A ‘floating currency’ is one
which has its exchange rate determined by the
international currency market.
The Australian dollar exchange rate is generally
expressed in terms of units of the United States dollar
for one Australian dollar. As such, it is the ‘price’ of the
Australian dollar, with a higher exchange rate therefore
indicating that the Australian dollar is worth more. If
the exchange rate increases, the Australian dollar is said
to have ‘appreciated’. Conversely, if the exchange rate
falls it is said to have ‘depreciated’.
Figure 2
US Dollar/Australian Dollar Exchange Rate
1.20
1.10
1.00
0.90
0.80
0.70
0.60
The chart in Figure 2 shows the US dollar/Australian
dollar exchange rate over the years 2010 to 2014.
Notice that the Australian dollar exchange rate has
been falling since mid-2013. This coincides with falls in
commodity prices, particularly the iron ore price. A fall
of this kind offsets some of the effect of a fall in
commodity prices, but it makes imports more
expensive.
The Australian dollar has been falling in 2015. Because
this increases export revenue, and is considered to be
good news for manufacturers, and farmers because it
makes them more competitive on the international
market. Minerals exporters also receive more revenue
and the local tourist industry is assisted. This all helps to
stimulate the economy.
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EMPLOYMENT
Australia’s unemployment rate was 6.0% in May 2015 7,
up from a record low of 4.0% in February 2008. A
sustained fall in unemployment is not likely until the
present downward trend in the GDP growth rate is
reversed and, as indicated earlier, this is not likely to
happen before 2016-17.
THE TERMS OF TRADE
Economists focus on the ‘terms of trade’ when they are
measuring Australia’s international trade performance.
The terms of trade are calculated as the ratio of export
prices to import prices expressed as a percentage. To
economists, increasing terms of trade indicate
improving economic performance, with the converse
also applying when the terms of trade is falling.
Australia’s terms of trade have been falling since
September 2011 after a steady upward trend, as
indicated in Figure 4. The fall is consistent with the
lower growth rate in GDP, as noted earlier.
THE BUSINESS CYCLE
THE BUSINESS CYCLE DESCRIBED
Although Australia has experienced a periods of
sustained economic growth in recent years, there is still
a business cycle.
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
recession has been reached. A recession is not
recognised until there have been two successive
quarters of negative economic growth, and in terms of
this definition Australia escaped a recession during the
Global Financial Crisis (GFC). Even so, there is still a
discernible business cycle moving from periods of
higher growth in output and higher interest rates, to
periods of lower growth in output and lower interest
rates.
We can map changes in the business cycle after they
have occurred by using Gross Domestic Product (GDP)
as a measure of economic output. The Australian
Bureau of Statistics releases GDP data once a quarter.
Figure 3 shows quarterly movements in GDP for the
twenty years to June 2014.
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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.

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This is indicated in Figure 5, which shows the
relationship between the rate of growth in housing
prices and mortgage rates for the period 2001 to 2014.
To understand the graph properly, you have to note
that the scale for changes in mortgage rates has been
inverted to ease comparison with the changes in
property prices.
Note the close relationship between housing price rises
and mortgage rate falls, as is evidenced by the way the
period of decreasing interest rates from 2011 onwards
has been accompanied by housing price rises.
Conversely, interest rate rises have been accompanied
by much smaller rises in housing prices and even
housing price falls.
Figure 511
With this relationship in mind, the Governor of the
Reserve Bank, Glenn Stephens, has warned that housing
prices may fall if the cash rate is increased.12 That,
however, is not likely to happen before 2015-16 at the
earliest.
GOVERNMENT AND THE BUSINESS
CYCLE
Traditional economics textbooks refer to the use of
‘fiscal policy’ as an alternative to monetary policy. Fiscal
policy is the use of changes in government spending
and taxation to either, depending on the circumstances:
 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.
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To a large extent, fiscal policy operates automatically.
During an economic downturn, there is a fall-off in
government revenue with lower taxation and an
increase in government spending because of an
increase in social security payments. This is stimulatory,
and it can happen without any deliberate government
decision to use fiscal policy to stimulate the economy. It
is likely to be accompanied by budget deficits and
increased government borrowing, as has been the case
in Australia since the GFC.
Likewise a long period of economic growth might be
accompanied by increased taxation revenue and lower
government spending – and hence budget surpluses.
This can help stabilise the economy when it is
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
automatic stabilisers, fiscal policy can be adopted very
deliberately – as was the case during the GFC in
Australia and also other countries with advanced
economies. The Australian government’s response to
the GFC, for example, consisted of two fiscal stimulus
packages that contained a range of measures ranging
from one-off payments to infrastructure spending.
Economists refer to an approach such as this as
discretionary fiscal policy, as opposed to fiscal policy
that is applied through automatic stabilisers. Compared
to monetary policy, discretionary fiscal policy has the
advantage of having an immediate impact on consumer
demand.
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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

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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.

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