National Economic Policy
a) Discuss the reasons for the main movements in Australia’s terms of trade over the last decade.
b) What could be the likely impact of a decline in the terms of trade on the Australian Economy? Analyse the impact on the macroeconomic variables in Australia, making use of the Mundell-Fleming model, assisted by diagrams.
c) Discuss the implications for monetary and fiscal policy of the decline in the terms of trade. Make use of diagrams in your answer.
Terms of Trade, a key indicator for economic activity has been falling for over four quarters in Australia. The figures, as per Australia Bureau of Statistics, state that import price index was down by 2.4% and export price index was down by 6.4% for the quarter ending September.Since terms of trade is the ratio of export price index to import price index, the terms of trade fell by 4.2% for the same quarter. 1A lowering term of trade is not beneficial to the economy since this means we are relying more on imports for our needs and thus puts a downward pressure on the dollar.
Terms of Trade is an index which calculates the relativity between export and import price indices. It is calculated as the ratio of export and import prices. If the index increases, it means that a country is better off in exports and giving out less for imports but if it is the other way, it means a country is receiving less money for its exports and relying heavily on imports.2 An increase in this relativity between prices gives way to a favorable movement. A fall in the terms of trade signifies that Australia’s export has fallen down in comparison to its imports. Australia Bureau of Statistics calculates terms of trade and publishes a terms of trade series every quarter.
Hence,Terms of Trade = (implicit price deflator for export of goods and services / implicit price deflator for import of goods and services)*100
Australia’s terms of trade has enjoyed a favorable terms of trade owing to the mining boom over the past so many years. The mining boom had resulted in an unprecedented growth for the exports of mining output. Australia’s economy has seen very good investments, labor demand,share price increase of mining industries etc.