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  • Writer's pictureShaun Brien

Interested in recent changes?

On May the 3rd, 2022. Phillip Lowe of the Reserve Bank of Australia announced that the cash rate would rise by 0.25 basis points from 0.1 to 0.35%. The first increase to the cash rate in over a decade.

This was then passed on in full by the 4 major banks meaning that interest rates would also increase by 0.25% for businesses and households.

This increase was largely to combat the 5.1% inflation rate created by the recent surges in cost of living throughout Australia. Impact on Aggregate Demand:

Interest rates refer to the cost of borrowing money or the reward for saving with a financial institution.

An increase in interest rates means that households who have a variable rate home loan are now likely to have less discretionary income overall as their interest repayments rise.

This is likely to lead to lower private consumption spending and increased private savings means that there are an increase in leakages to aggregate demand.

This is also likely to lead to decreased injections to aggregate demand as businesses are less likely to conduct private investment spending as the cost of borrowing as risen.

Therefore aggregate demand is likely to fall overall.


Impact on Domestic Macro Goals: Low Inflation: A decrease in aggregate demand relative to aggregate supply puts downward pressure on prices as businesses discount prices to clear excess stocks, therefore decreasing demand inflationary pressure and making it likely the current 5.1% inflation rate will ease.

Therefore the goal of low inflation of the general level of prices increasing at a rate of 2-3% on average over time is more likely to be achieved as inflation eases.


Full employment: A decrease in aggregate demand relative to aggregate supply leads businesses to lay off excess workers as economic activity falls and production slows therefore increasing the unemployment rate from the current 4%.

Therefore the goal of full employment (the lowest rate of unemployment without causing unnecessary inflationary pressures where only around 4.5% natural unemployment exists) is likely to still be achieved in the short term unless significant layoffs occur.


Strong and sustainable economic growth: A decrease in aggregate demand relative to aggregate supply leads businesses to slow production in response to decreased economic activity therefore leading to the rate of economic growth falling.

Therefore the goal of strong and sustainable economic growth (the highest growth rate possible without creating unnecessary inflationary, external or environmental pressures where Real GDP growth is 3-3.5% per annum) is likely to ease from 4.2% back towards the goal range.


Impact on Aggregate Supply: Interest rates refer to the cost of borrowing money or the reward for saving with a financial institution.

An increase in interest rates means that businesses face higher costs of production as they have higher interest repayments on their business debts.

Businesses are then likely to pass on these costs to consumers via higher prices to protect their profit margins.

Businesses are also likely to layoff excess workers to protect profit margins. This leads to a decrease in aggregate supply overall.


Impact on Domestic Macro Goals: A decrease in aggregate supply is likely to lead to:

Low Inflation: Businesses passing on increased costs via higher prices to protect their profit margins. Meaning increased cost inflationary pressures.

Therefore the goal of low inflation of the general level of prices increasing at a rate of 2-3% on average over time is less likely to be achieved as inflation rises.


Full employment: A decrease in aggregate supply from an increased cost of production means that businesses are likely to lay off excess staff to protect their profit margins, therefore increasing the rate of unemployment.

Therefore the goal of full employment (the lowest rate of unemployment without causing unnecessary inflationary pressures where only around 4.5% natural unemployment exists) is likely to still be achieved in the short term unless significant layoffs occur.


Strong and sustainable economic growth: A decrease in aggregate supply due to increased costs of production is likely to disincentivise businesses from production and therefore reduce the overall levels of production and economic growth overall..

Therefore the goal of strong and sustainable economic growth (the highest growth rate possible without creating unnecessary inflationary, external or environmental pressures where Real GDP growth is 3-3.5% per annum) is likely to ease from 4.2% back towards the goal range.

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