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Understanding the Australian economy

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The Reserve Bank of Australia (RBA) decisions about the cash rate are not just about setting the interest rate for mortgages. The economy is not controlled by one set of numbers but reviews a variety of factors.

It helps to understand the various signals that experts look for when making decisions that will ultimately affect your pocket book. For most households key indicators that affect your daily life the most are interest rates, inflation and unemployment.

By staying abreast on the economic signals, it can assist you in making wise financial decisions and not get caught out.

Here are my top 10 basic economic factors worth understanding:

1. Cash rate: The cash rate also called the official interest rate, and it is the interest rate off which all borrowing is based. The rate is controlled by the Reserve Bank, though technically it is the rate the banks charge each other for overnight borrowing, in order to maintain positive balances with the Reserve Bank. When the economy is improving, the Reserve Bank raises interest rates to slow the economy; when the economy needs some stimulation, interest rates are reduced to low levels such as today's 2 per cent. The Reserve Bank uses the cost of money to control demand.

2. Inflation: inflation is the rising cost of goods and services. The RBA uses the cash rate to keep inflation within the bounds of two and three per cent. The idea is that when money is cheap, we’ll spend a lot and prices will rise; when interest rates are high, we won’t spend so much and prices won’t rise so fast. Inflation is currently 1.7 per cent – don’t expect a rate rise soon.

3. GDP: the growth of gross domestic product (GDP) measures how fast the economy is growing. GDP growth is like a national scorecard and is currently around 3.0 per cent, above the global trend.

4. Global growth: the RBA looks at global growth because it defines the health of our broader market place. The IMF put global growth at 2.4 per cent in 2015 and forecasts 2.9 per cent for this year.

5. Labour market: strong employment is essential when you control the economy with interest rates. Banks won’t lend to those with no job and economic confidence is weak with high unemployment. The Australian unemployment rate is currently 6.0 per cent, in comparison Canada is 7.2 per cent and in the UK it’s 5.1 per cent.

6. Exchange rate: the current ‘low’ exchange rate of the Australian dollar against the US dollar is more a return to trend. It makes some imports more expensive but it helps exporters. 

7. Industrial vs services economy: the RBA refers to the ‘mining economy’ and the ‘non mining economy’ (all industries other than mining).  Economic growth has traditionally been based on the mining industry in Australia which is currently not experiencing growth. However Australia has seen recent growth in the non-mining sector. This economic transition matches the recent Chinese shift from industrial to a services economy.

8. Household consumption: household consumption equals consumer confidence in buying and selling goods and services. It is currently strong.

9. Balance of trade: this is simply the difference between how much we export and how much we import. Every economy would love to export more than it imports and Australia usually hasn’t. Since 1971 our normal state is to be trade deficit.

10. Business investment: one of the big stimulants for not only the economy but the jobs market is business investment. In 2015 capital expenditure was down around 16 per cent on 2014