Why a slowdown in productivity is likely to cause economic problems?
A slowdown in productivity growth is likely to be a cause of worry for the Governor and Board of the Reserve Bank of Australia because of several reasons. However, before, these reasons are explained, it is crucial to understand how the aggregate demand and aggregate supply model work. The model stipulates that aggregate demand and aggregate supply determine the average pricing of goods and services in the economy (Mankiw 2011, p. 458).
This is also known as the equilibrium price. Graphically, this point is believed to be where the aggregate demand curve and aggregate supply curve meet. If this equilibrium is not achieved, there is likely to be an increase in prices or a decrease in price (which may affect the consumers or producers, negatively).
Assuming there is sustained exogenous growth in aggregate demand, the governor and board of the reserve bank need to be worried about the trend because the projected productivity growth will not meet this demand (Thomas 2005, p. 452). The projected productivity growth is the same as the supply of goods and services. Concerns against this situation are evident because there will be too much money chasing very few goods in the market. In such a case, there will be a subsequent increase in the prices of goods and services in the economy because the producers will be at liberty to hike prices without any significant impact on the demand for the same goods and services (Mankiw 2011, p. 458).
Such a scenario will cause an increase in inflation for the general economy, where goods and services will be more expensive than they ordinarily are. In such a situation, several monetary policies need to be formulated and implemented by the governor and board of the reserve bank. However, most of these monetary policy changes will be aimed at increasing productivity in the economy. Nonetheless, this is the ideal situation because the increase in prices is caused by the underperformance of the economy’s productivity levels.
In the short term, it would be advisable for the governor and board members of the reserve bank to control the amount of money circulating in the economy (Maier 2007). This is a tool to regulate the increase in aggregate demand through monetary policies. Such monetary policies may include expanding the interest rates for borrowing money, so that, most people are discouraged from borrowing, thereby reducing the amount of money in circulation (within the economy).
Such monetary policies are likely to be formulated to curb the inflationary problems likely to be experienced from an increase in aggregate demand and a slowdown in productivity growth. The ideal situation would involve an increase in aggregate supply and an equal increase in aggregate demand (Mankiw 2011, p. 458).
Why the cash rate should be unchanged?
The board of the Reserve Bank of Australia may have kept the cash rate reserve steady while the inflationary pressures are expected to rise, for several reasons. Considering the global economy is performing poorly, there are several factors that are still unknown and can severely affect the country’s economic outlook if the cash rate reserve is changed. However, looking into the local Australian context, the country’s terms of trade which have been considerably high, have ensured that, the Australian population receives more income than they have done before (City News 2011).
This trend has also resulted in an increase in the country’s national income. To this extent, changing the cash rate may cause more damage to the economy by encouraging more cash flow in the economy, and at the same time, not adequately supporting the investments needed to support productivity growth.
The Australian economy is also experiencing considerable investments in some of its key economic sectors, such as the service sector and the resource sector, which is projected to increase productivity growth (RBA 2011) automatically. The productivity growth is also likely to reduce inflationary pressures in the long-run, thereby providing a natural check for the country’s inflation. If the country’s reserve bank attempts to change the cash reserve rate to check the rising inflationary pressures, and the investments in some of the country’s main economic sectors materialize, there is bound to be a significant level of instability in the economy. It is therefore justifiable for the national reserve bank to keep the cash rate steady while these economic factors play out.
Furthermore, the global economic environment is too uncertain about making any significant adjustments to the country’s cash reserve rate. This is important, considering the economic uncertainties in Europe and the United States (US). These uncertainties are coupled with financial volatility which may equally cause more people to adopt a cautionary approach to spending because there are too many economic fears currently in existence (such as a rise in the unemployment rate) (Intermedia Group 2011, p. 1).
This situation has caused an almost complete loss in consumer confidence. This situation also paints a very uncertain economic environment for the national reserve bank to make any significant changes in the cash reserve rate. This decision is supported by the fact that there is too much risk in the global economy for the Reserve Bank to make any drastic monetary policy changes. The best environment to make these changes would, however, be an environment of certainty.
City News. (2011) Cash Rate Unchanged. Web.
Intermedia Group. (2011) Call For Cut To Cash Rate Dismissed. Web.
Maier, M. (2007) Introducing Economics: A Critical Guide For Teaching. New York, M.E. Sharpe.
Mankiw, G. (2011) Principles of Macroeconomics. London, Cengage Learning.
RBA. (2011) Cash Rate Left Unchanged. Web.
Thomas, L. (2005) Money, Banking, And Financial Markets. London, Cengage Learning.