Economic Growth

Demand Factors and Sustainable Economic Growth (2)

Demand Factor	Theoretical Link to Growth	Evidence
Interest rates	When interest rates are decreased the discretionary income of consumers and businesses will increase. As a result, we may see increased spending on consumption items (C) and business investment (I). (It is important to remember that there is an 18 month impact lag with changes in the cash rate.)	Interest rates were increased to 7.25% in early 2008. This helped to cause the fall in investment spending that was seen at that time, and also in the twelve months that followed. By mid 2009 economic growth was recorded at just 0.6%, and the economy had experienced a negative growth outcome in the December quarter of 2008.
Business Confidence	As business managers become more confident they will also be more willing to invest in the future. This may mean an increase in investment spending (I) and hence an increase in aggregate demand.	When business confidence fell in 2008/09 (eventually reaching -30.5 on the NAB index) growth also fell to 0.6%. On the other hand, improved business confidence in the second half of 2009 helped to ensure that the economy returned to positive growth in 2010.
Wage levels	If wages increase this will allow for higher disposable incomes amongst the public. Again, this should lead to an increase in consumption spending (C) and therefore an increase in aggregate demand. There may be a slight lag in the impact on the economy associated with changes in income levels. (Australians have experienced a decade of very strong growth in wages.)	Average weekly earnings for a full time employee increased to over $1,200 in 2009, an annual income in excess of $60,000. However, during the same period many people were forced to work fewer hours, and as a result the overall amount of income received in the economy fell. This put downward pressure on consumption spending, and economic growth was lower during this period.
The value of the Australian dollar	Changes in the value of the AUD will affect the willingness of people and businesses overseas to purchase our exports (X). If the AUD depreciates, this will lead to our products appearing relatively cheaper on the international market, and therefore our exports should increase. This equates to an increase in aggregate demand.	The Trade Weighted Index increased rapidly after early 2009, and as a result our economic growth fell to 0.6% in that year. (It is important to note that changes in the value of the AUD also have a strong supply side impact, which will be discussed separately.)
Income Tax Rates	If income tax rates fall, consumers will have a higher disposable income. Even though their actual pay has not changed, they will have more money to take home. This will lead to higher levels of consumption spending (C) and therefore higher levels of aggregate demand.	Income tax rates were lowered consistently between 2006 and 2009. This resulted in higher levels of disposable income, and therefore increased consumption spending. There is no doubt that this helped to counteract the negative impact of the global financial crisis at this time, which is why the Australian economy was able to return to strong growth after just one quarter of negative economic growth (in December 2008).
Government Spending	The government sector is a vital part of the aggregate demand formula. By choosing to increase their spending (G), the government is directly adding to the level of aggregate demand in the Australian economy.	In response to the financial crisis of 2007-2009, the Australian government launched a series of fiscal stimulus packages. These packages resulted in deficit budget outcomes for 2008/09 and 2009/10. Although economic growth was lower during this period, it is also true that Australia was one of the few advanced economies in the world to avoid a technical recession at this time.
Overseas Economic Conditions	If our major trading partners are experiencing strong economic conditions, then it is likely that they will demand more of our exports. The increase in demand for these goods and services will lead to an increase in aggregate demand.	In 2008 the US economy moved into a recessionary phase of the business cycle. As a result our exports to that area decreased, which reduced aggregate demand in Australia. This resulted in our lower growth figures at that time - growth fell to -0.5% in the December quarter of 2008. During 2009, the ongoing impact of the crisis in the USA resulted in lower economic growth in Australia.

Current Page: Demand Factors and Sustainable Economic Growth (2)