External Stability

Supply Factors and External Stability (2)

Supply Factor	Theoretical Impact	Evidence
Interest Rates	Interest rates represent a very significant cost of production. If interest rates fall, suppliers will be more able to produce their goods and services, and so aggregate supply may increase. If the local market has already been saturated then they will have to find a market in the international economy. Australia has excellent resources available to assist a business of any size to do just this. As a result, a fall in interest rates may lead to an increase in exports (especially when you consider that falling interest rates can also lead to a depreciating AUD).	Between early 2008 and mid-2009 the cash rate was cut from 7.25% to 3.0% - a cut of 425 basis points. During the same period the CAD/GDP ratio contracted to -4.4%.
Wages	Like interest rates, wages represent a cost of production. Over the past five years Australian wages have increased every year. In theory, stable wages over an extended period should allow for an improvement in our international competitiveness, and so our ability to export may improve. Higher wages would make it less likely that we will be able to sell our production on the interational market, and so our external stability might suffer.	In the period between 2007 and 2010 the RBA was particularly concerned about the possibility of a blowout in wage costs. While average wages did increase (reaching $1,200 per week for a full time adult in 2009), businesses were able to reduce their wage expense by decreasing the number of hours employees worked. As output levels were maintained this increased international competitiveness, and therefore the CAD contracted to -4.4% of GDP in 2009.
Exchange Rate	Once again, although the exchange rate is a separate measure of external stability it is also an important determinant of trends in the other factors. A depreciating exchange rate will mean that raw materials that are imported for use in production will be more expensive. This may lead to a fall in aggregate supply. We have already established that there may be an increase in demand when exchange rates fall – to satisfy this demand producers may rely in the short term on clearing existing stocks.	During 2009 the Australian dollar appreciated, contributing to the very small increases in input costs that were seen during this year. (In fact, for many input prices overall costs fell in that year.) This reduced the total cost of imports, and helped to encourage exports. Once again, this contributed to the contraction of the CAD (to -4.4% of GDP) that was seen at that time.
Price of Raw Materials	The price of raw materials will be affected by relative wage rates, interest rates and the exchange rate. When raw materials increase in price, suppliers will be reluctant to allocate resources to the production of this item. They may also pass on this cost increase in the form of higher prices. As a result, an increase in the cost of raw materials may lead to cost inflation, and a decrease in the international competitiveness of Australian businesses.	The increase in producer input costs peaked in 2007/08, which corresponded with the CAD being recorded at -5.2% of GDP. On the other hand, when the price of raw materials increased by only 2.1% in 2009, the CAD contracted to only -4.4% of GDP.

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