The gross domestic product (GDP) is one of the most basic economic indicators that people use as a benchmark that provides insights into the overall health of an economy (Investopedia, 2007). However, the number by itself does not provide much relevant information. In fact these numbers are so large that it is hard for most people to put this in any kind of perspective. Rather, it is how the number change that helps people to gain a perspective on what the economy is doing on a macro level. For example, if the GDP is stated in terms of it rising or falling over a course of a fiscal year then it has greater relevance. A three percent increase in GDP over the course of the year would mean that the economy is expanding at a fair rate.
Measuring GDP is a complicated task. There are two basic approaches that are used to estimate this figure. The first is to use a compilation of different income sources. The economists who compile this data will add up all the various sources of income data that are present in the economy. These include employees' payrolls, private and public revenues, investment incomes, etc. Another way to estimate GDP is by adding up what everyone in an economy spent; known as the expenditure method (Rasper, 2008). This approach considers factors such as consumption, gross investment, government spending, and the difference in exports vs. imports. Theoretically, both approaches should produce the same number. However, in reality they are different because of the complexities that lie in accounting for these numbers; yet they are still generally fairly close.
1.2 Real GDP Overview
Real GDP uses nominal GDP for a base figure but adjust this figure for inflation. GDP can either increase decrease in regards to one of two factors. Either the total volume goes up and the economy is actually producing more, or the GDP figure could also rise or fall if the price levels fluctuate. Therefore, it is possible to have an increase in nominal GDP without the economy actually producing any more goods or services. Therefore it is important to distinguish any changes in GDP based on whether the GDP figure's movement was due to the economy expanding or simply due to inflation or deflation (Lin, 2008).
In order to calculate real GDP, economists must also calculate what is referred to as a price index. The price index is a collection of data that examines how the effects of inflation alter prices in the economy. The index will track prices on a basket of goods including food, clothing, housing, health, transport, education, and many other commonly purchased goods and services in the economy. By tracking the collection of prices, economists can then estimate how prices are moving in these different market segments as well as in the whole economy. This data is generally released on the fourth Wednesday of the month after the reference quarter (Australian Bureau of Statistics, 2012).
Figure 1 - CPI 2nd Quarter Results ( Australian Bureau of Statistics, 2012)
GDP, and especially real GDP, are considered the central measure of the overall economic activity primarily because its long and short run movements are correlated with many factors of interest to economists and policy makers alike (Hobijin & Steindel, 2009). The foremost examples of the correlations that are of the most interest are items such as the income, inflation, and unemployment. This can also provide insights as to what the tax base and tax revenues might be for any given year which would be relevant to public administrators and policy makers.
The long-term historical correlation between real GDP and unemployment is roughly -.70 -- meaning that when real GDP growth occurs that it is very likely for unemployment to decrease and vice versa (Hobijin & Steindel, 2009). There is also a fairly strong correlation between real GDP and inflation. Therefore, the movements in real GDP alone can provide insights into the health of the overall economy, but also the likelihood of other key factors. Because of this usefulness, GDP serves as the benchmark indicator for economic health.
2. Money Aggregates
2.1 Money Aggregates Overview
Monetary aggregates serve as complimentary measures to GDP and real GDP. These aggregates are watched closely by economists and investors, because they can provide insights into the "true" size of the money supply (Investopedia, N.d.). For example, if monetary aggregates are growing quickly, then it could result in inflation and price increase across the board. However, if the money supply is contracting then there could also be a deflationary period. These aggregates were once a central consideration in central bank policy; however the last few decades have shown a lower correlation with key metrics like inflation, GDP, and unemployment (Investopedia, N.d.). Therefore although these metrics are still valuable tools, their central role in determining monetary policy is slowly diminishing and a wider range of variables must be considered.
2.2 Borrowing and Lending
One financial aggregate that is commonly used is the borrowing and lending activities that are occur through any given time period. These activities can be compiled and provide a total credit sum which can then be tracked over time similar to GDP. The Reserve Bank of Australia provides data on housing credit, personal credit, business credit, as well as other forms of credit (RBA, 2012).
Figure 2 - Two-Year Money Aggregate Data (RBA, 2012)
Inflation can be considered a rise in the level of prices of goods and services in an economy over a period of time; consequently when prices decrease over time this is referred to as deflation. When prices rise, this reduces the purchasing power of money. For example, if you had one hundred dollars in one year, but prices were raised by ten percent the next year, then you one hundred dollars would not purchase as much as it would have in the previous year. This phenomenon can have both positive and negative effects on the health of the overall economy.
Low inflation can negatively impact an economy because it diminishes the incentive for investment. For example, if a potential invests knows that their money is going to be roughly worth the same as is currently in the future, and then there is not much of an incentive to use this money as capital in an investment activity. However, if the value of money is diminishing, this provides a stronger incentive for the investor to put this money towards some investment activity so that it can mitigate the effects of inflation.
The Australian Consumer Price Index (CPI) has been constructed over time to measure the price changes facing households. The index is based off the prices of a basket of goods and this basket is reviewed and reweighted every six years (RBS, 2011). This index is the most comprehensive measure of goods and services price inflation faced by all consumer households. However, there are other methods of judging inflation as well. One alternative measure is the cost of living index which considers how much money it requires to maintain a certain lifestyle. Although this is similar to the CPI, there are many subtle differences. The CPI takes a more comprehensive and objective approach to tracking price levels.
Figure 3 - Inflation since the Beginning of the Twentieth Century (RBS, 2011)
4. Health of the Australian Economy
Australia has one of the most robust economies in the world. The country has been the envy of many due to the fact that it withstood entering into a recessionary period during the global downturn (Canberra, 2010). The current inflation rate was recorded at one point two percent in the second quarter of 2012 which is remarkably low by world comparisons. Although, as previously mentioned, low inflation rates can actually stifle investment and sometimes put upward pressures on unemployment. Yet Australia's unemployment remains fairly low as well hovering in the neighborhood of five percent; with somewhat of a step jump of about half a percent in the last quarter (Trading Economics, N.d.).
Australia's GDP growth rate has remained fairly stable since the global downturn while posting very modest gains. The GDP growth rate was a little over one percent in the last quarter. Though this is a comparatively good position with other Western nations, a larger GDP growth rate would be more ideal. Raising the money supply and increasing investment activities could work as a stimulus to the economy and the GDP growth rate. However, the global economy is also facing potential crises in Europe and in other parts of the world as well. One result might be an influx of foreign investments that are targeted to take advantage of Australia's stable economy due to volatility elsewhere in the…