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Stagflation and Gloomy New Zealand Economy
Lecturer: Mr.Gamini Jayasuriya
Module Name: 4.703 World Economy
Student Name: Patel Shaurin B.Student Number: 20080541MBA: 83Assignment Due Date: August 27, 2008.
(Word Count: 2575 Including References)
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Table of Content
1. Introduction.......
2. Stagflation and New Zealand Economy..
3. What can be done in this situation......................................................
4. Conclusion..
5. Bibliography..
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Introduction:
The countrys economy depends on the various factors like government, savings,
consumers, investments, businesses and overseas sectors.
(http://www.amosweb.com/images/CFIm001w.gif)
The above diagram shows how the economy works. There are three Macroeconomic
Sectors; Business, Household, & Government. There three Macroeconomic Markets;
Financial, Resource, & Product. The goods and services are produced by firms which are
being consumed by households. Households save money in banks; banks lend that money
to business for investment in new businesses and create new jobs. When consumer is
spending more firms invest more, government receives more tax revenue, which shows
economic expansion in country. When consumer spends less, then firms do not invest in
businesses much more and in result the circular flow of economy starts to slowdown. The
import from foreign firms is the leakage in the flow because the country has to pay
money through currency exchange to the foreign country, and the export is the income
which country receives through the selling of goods to the foreign country.
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(http://www.financialsense.com/Market/cpuplava/2007/images/0314.h1.gif)
Every country faces the peaks falls in their economies. When economy is expanding it
goes to peak level and when there is lack of resources like labor, infrastructure, higher
production and lower demand then economy settles its way with the true economical
situation. The present period is not good for domestic (NZ) as well as global economies.
Talking about problems with New Zealand economy it is facing economic stagnation and
rising inflation. The current situation could be defined as economic Stagflation.
Stagflation and New Zealand Economy:
It is state of economy when the economy is struggling with its demand supply problems
which result in inflationary problems and the country is slowing down because of scarcity
of resources, decline in consumer spending, decline in new business investment
confidence, factory output tumbles, unemployment rises, interest rates at higher level, etc.
Under such economic condition economy is facing rising inflation on one hand and on
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other hand it faces economic recession. It could be caused by some specific reasons like
if a country is importing commodities from other countries e.g. oil then is the price of that
commodity rises that country has to increase the price of relative products which makes
production less profitable and results in slowdown in economy. Secondly the damage
could be done by inappropriate macroeconomic policies of the country, like central bank
cause inflation by printing and circulating huge amount of money in the economy and
government can cause stagnation by putting more rules for goods and labor market.
Figure:
(http://www.harpercollege.edu/mhealy/ecogif/asad/asfedec.gif)
A shift of AS to the left shows decline in supply which will reduce output of firms and the
price will go upwards as the supply decreases. This would cause more unemployment,
slow down in economic growth rate and push inflation or prices upwards because the AS
(supply) is decreased. This inflation could be called "cost-push" inflation. It is inflation
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caused by decrease in AS curve. The situation will result in situation of Stagflation as
decrease in output, increase in unemployment and rising inflation coupled with the slump
in economy. It is inflation caused by higher input costs, lower supply and growth in
emerging economies which led the growth in the export of food items, milk, cheese, etc
items which can be a factor for pushing food product prices higher. New Zealand imports
oil so unexpectedly rise in the oil prices pushed the cost of food products by 2.2%,
transportation cost rose by 4.9%, production cost also increased. The rise in Energy and
Food prices are the main perpetrator for rise in Inflation. As there is rise in the food
products the situation could be Agflation.
(http://www.raboplus.co.nz/binaries/Inflation,%20agflation,%20stagflation%20-
%20what%20it%20means%20for%20investors_tcm36-49873.pdf)
So the current situation is situation of Stagflation as far as New Zealand economy is
concerned. Higher inflation means companies under allow for reduction and twist
economic situation. The rise in oil prices was due to the rising demand from the emerging
economies like China, India, etc. The production by OPEC was pretty flat it wasnt
increased as the demand increased in developing countries.
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The oil price move was a little bit technical move as by the move marginal buyer of the
oil is not out of the market and the demand and supply is going to settle again. The oil
prices rose about 50% ($147/bbl) in last one year which pushed product prices higher
which resulted in higher inflation rate despite the economy is facing downturn. But we
can see the oil prices have fallen consistently in the last one month as the increase in the
oil output by OPEC and slowing demand in the worlds largest developed economies.
(http://www.anz.co.nz/about/media/liabrary/mf/mf20080721.pdf)
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The above graph shows how the inflation changed with the growth or downturn in
economy in New Zealand from year 1995 to 2008. As we can see the circle in the graph
which shows rising inflation but the GDP growth is being going into recession. As we
discussed above the rise in inflation is being driven by the rise in the commodity prices
globally. The fall in US dollar could be one of the factors that led the commodity prices
up as the dollar was down the demand and supply adjusted with that rise.
As per the data available the NZ economy is going in recession from current levels. It is
expected that the calendar year growth could be around 0.3%, which shows the negative
economic growth. The country is facing offshore headwinds and a massive de-leveraging
process across households the recovery looks tough. Consumer spending has been
declined as the retail sales over recent times have been declined.
(http://www.anz.co.nz/about/media/library/mf/mf20080728.pdf)
The unemployment rate for June quarter was 3.9%. Which risen from 3.7% in March.
And there are no signs of cooling off of unemployment. However the country gained the
27,000 new jobs in recent weeks from the 29,000 jobs it lost in the recent months.
What can be done in this situation?
There are various options for the policy maker to choose from. It depends on what the
policy makers want to decide about the economy, it remains million dollar question.
There are mainly five policies a policy maker could choose from. All the policies the
authorities take they are for stabilizing the economy. Either authority is trying to bring
full employment and economic growth or want to reduce the inflation.
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Fiscal Policy: In this policy government manage economy through implying taxation,
spending or borrowing. The long run recurring behavior of this policy is that the level of
debt falls when the country enters in the boom phase of its business cycle. It is long run
policy; it has some time leg to be effective.
Fiscal contraction policy:
(http://www.harpercollege.edu/mhealy/eco212i/lectures/ch8-17.htm)
The goal here is to curb inflation in the country. If a country wants to adopt this policy
then it has two ways.
The government budget under fiscal policy is balanced. i.e. G=T. Means Government is
totally funded by the tax income it receives. But under the contraction fiscal policy the
situation is like ~ G
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- Increase in taxes.
The use of the policy would shift the AD to left. Means reduction in aggregate demand by
increasing taxes so that the consumer will spend less and governments budget deficit
will improve or reduce the government budget for better budget surplus. But is has some
drawbacks like is consumer will spend less then economy will start slowing down, and in
the situation of negative economic growth it will take economy into further deep
slowdown in economy. It will decrease inflation but it will increase unemployment and
effect of depression in depth.
So, For New Zealand it would not be good policy to use otherwise the economy will go
in further deep recession.
Fiscal expansionary policy:
The policy involves the government to push the economic growth by spending more on
services, infrastructure, etc. or by cutting down taxes to boost economic growth.
Traditionally it was used to curb unemployment, increase economic growth.
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(http://www.culturaleconomics.atfreeweb.com/111%20114%20MBB%20Macro%20Grap
hics/Macro/Fig%209.1Expand%20FP.jpg)
The increased government spending or reduced in taxes would increases from AD0 to
AD1. So, AD curve would shift to the right side. This would increase real GDP, reduce
unemployment but on the other side increased money on the hand of consumer will raise
consumer spending and hence increase inflation/price level from P0 to P1s. The policy
increases the governments budget deficit or government has to borrow aggressively to
help the economy. (http://en.wikipedia.org/wiki/Expansionary_fiscal_policy)
But it can not be used in the New Zealand, as the country is facing situation of rising
inflation already and economic growth is also slowing down.
Monetary Policy:
The policy is course of action taken by government, central banks, etc. which controls
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- Supply of money
- Availability of money
- Cost of money (Interest rate).
The benefits of the policy would be
- Stable economic growth
- Price stability
- Exchange rate stability.
(http://www.chr.up.ac.za/ggp/coursematerial/2006/good_gov/Goodgovernance_MPFP.pdf
)
Contractionary monetary policy:
It is used to decrease supply of money as the policy is controlled by the Finance
department of any country or Central bank. When money supply has increased in the
economy and there is rising inflation authorities take action to combat rising inflation.
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(http://www.harpercollege.edu/mhealy/eco212i/lectures/ch8-17.htm)
The main objective is to curb the inflation. For that central bank raises inflation rate
which increases the cost of money which results in decrease in money supply in the
economy. The action results in shift of AD curve to the left side which shows reduction in
demand of money because of high borrowing cost for money. By this way they get
control on inflation but the economy slows down further and unemployment rises.
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(http://www.rbnz.govt.nz/keygraphs/Fig7.html)
The above shows changes in OCR in the past years in New Zealand. Currently the OCR
is 8% but it is 0.25% lower that its high of 8.25% which shows the higher borrowing cost
for the business to invest in businesses. By this was the country was pretty well managing
inflation but it caused in slowing down economic growth. So this policy could be better
to curb inflation but not enough to give economy to boost up.
Expansionary monetary policy:
The policy is used to increase the flow of money in the country. It can be done by any
open market operation e.g. Govt. buys bonds from market and in return supplies cash in
the market. Monetary policy affects the monetary variables such as price variables and
interest rates.
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The above graph shows the use of expansionary monetary policy effects on the economy.
After implementing expansionary monetary policy the AD curve shifted right side from
AD1 to AD2 which shows economic expansion or growth in real GDP, reduction in
unemployment. The price level or inflation in the economy will take toll as there is
increase in money supply in the economy. It can be done by making lower Credit Reserve
Ratio for banks so that banks can give more money to the people and hold fewer amounts
in assets. Central bank could allow more risk taking lending to the people of the country
by the banks. It can also decrease the interest rate or official cash rate so that borrowing
cost reduces and investors can borrow money and invest in economy. The flow of money
becomes easy as reduction in interest rate.
New Zealand recently reduced the OCR by 25bps to give some relief to economy. RBNZ
thought saving the economic is first job then curbing the rising inflation. Because as the
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