By Nicki Hutley
Understanding economic concepts can be a powerful tool to help you in making decisions about your work, your purchasing choices, and borrowing and investing. It can also help to better understand what our politicians are talking about. But economists don’t always make it easy, so we’ve put together a quick guide to commonly used terms that we think could be useful.
Monetary Policy – When the economy is running too hot (high inflation) or too cold (high unemployment), the Reserve Bank of Australia, or RBA, uses monetary policy to try and steer the economy in the right direction. It has three ways of doing this, but the most common is by setting interest rates (the cash rate). When rates are higher, more people have less to spend, which makes it harder for businesses to increase their prices. When rates are lower, people spend and businesses invest to create more jobs and economic growth. Unfortunately, while monetary policy can be good at bringing down inflation, it does this by slowing the economy, which leads to higher unemployment.
Cash Rate – On the first Tuesday of every month, the Board of the RBA meets to set the cash rate, which is the interest rate that banks pay to borrow funds from other banks. This sounds boring, but it catches a lot of media attention because the cash rate influences all other interest rates, including mortgage and deposit rates. When the cash rate goes up (or down), so does the rate you are charged for your mortgage, personal loans, and credit cards.
Inflation – Inflation measures the rate at which prices are changing over time. The main measure of inflation is the Consumer Price Index, or CPI. The CPI is made up of changes in the price of hundreds of different goods that an average household buys such as bread, fruit, meat, hairdressers, school fees, beer, BBQs, electricity, cars, petrol, and toothbrushes. In any one period, some prices go up while others may fall. The RBA has a target for ‘underlying’ inflation, which takes out items that tend to jump around a lot—such as petrol and some foods—of 2% to 3%. When inflation is higher than this target and rising, the RBA is likely to increase the cash rate. Underlying inflation at the moment it is 5.2%, but falling.
Gross Domestic Product – Gross Domestic Product, or GDP, is a measure of the size of our economy. GDP, which is reported every three months, tells us how individuals, businesses and governments have spent and invested. It covers everything from toothbrushes to roads. It also tells us which parts of the economy are doing well or not. Economists are most interested with how GDP has changed between one period and the next – whether we are in a period of growth or not. If GDP falls for two quarters in a row, that is defined as a recession. Sometimes, economists also talk about “trend growth”, which indicates how fast the economy can grow without setting off inflation. In Australia, trend growth is about 3% per year. Actual growth at the moment is just 2.1%.
Stagflation – This term was coined in the 1970s to describe a period when economic growth is low, or shrinking, and inflation is high. One example is 1983, when inflation hit 11%, but the economy was in a recession. Fortunately, stagflation doesn’t often happen, but at the moment Australia has a very mild version of this with inflation well above the target and economic growth below trend.
Productivity – One of the most important economic indicators is productivity. Productivity is a measure of how much we produce for each hour worked. When we work ‘smarter’, productivity goes up. This matters because productivity is one of the key ingredients into improving our standard of living. When productivity rises, businesses do better, which means higher profits and/or wages. How do we get productivity to grow? We can increase investment in machinery and technology to help us do our jobs more efficiently, we can improve the ways a business operates, and we can invest in peoples’ skills. Governments can also help improve productivity by making it easier for businesses to do business and investing in infrastructure such as roads and telecommunications.
Fiscal Policy – Fiscal policy is complex because it needs to balance what people want and need from their governments (schools, hospitals, roads, defence, child care, and so on) with the requirement to pay for those things through taxes. On top of that, it needs to take into account the overall effect of those decisions on the economy. Spending too much can make inflation worse and undo the work of monetary policy. Spending too little can lead to falling living standards. The most important day in the fiscal policy calendar is the second Tuesday in May, when the federal government hands down its budget. The budget is in deficit when the government spends more than it receives, leading to an increase in debt. At the moment, Australia’s debt is considered to be very manageable, and we are one of only nine countries in the world to have an AAA rating. (The others are: Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, and Switzerland.)
Labour Force – This is the number of people either in work (employed) or looking for work (unemployed). The Australian Bureau of Statistics counts you as employed even if you only work one hour a week! And you don’t count as unemployed unless you are actually looking for work. If you’re not working and not applying for jobs, for any reason, then you are not counted as part of the labour force.
Underemployment – Unemployment is reported on each month and represents the number of people actively looking for work, as a per cent of the labour force. But there is also a concept called underemployment, which is people who are working part-time but would like to work more hours. Unemployment and underemployment added together gives us the underutilisation rate. Policy makers look closely at this to see if there is likely to be wage pressure, which could in turn lead to inflation. At the moment, unemployment is 3.6% and underemployment is 6.4%. So one in ten Australians is looking for a job or for more work.
Exchange Rate – This tells you how much you’ll get if you are changing your Australian dollars into another country’s currency (or theirs into ours). If you are lucky enough to have an overseas holiday planned, you’ll be following the exchange rate for the country you’re visiting to see how much things cost on the ground. Exchange rates also matter when you are buying products from overseas (imported goods) such as a car, or petrol. When the Australian dollar falls, we pay more for imports.
Cryptocurrencies – Most people have heard of Bitcoin, the most commonly used cryptocurrency. Unlike banknotes or coins that have a physical form, cryptocurrencies can only be accessed using computers or other electronic devices. It’s important to know that cryptos, as they are sometimes called, are not the same as ‘real’ money. They are not regulated, and buyers are not protected. Cryptos are not accepted by many sellers, so they are not that useful as a form of money. While the Australian dollar does move around a little from day to day, cryptocurrencies are often very volatile. As an investment, buying cryptos is highly risky and more than 2,000 failed between 2013 and 2022 through lack of trade, fraud, and even because they were launched “as a joke”.
Together, we’ve delved into the intricacies of some key economic concepts and terms that are frequently used when discussing the state of the economy and the impact it is having on our lives. Deciphering the complexities of economics isn’t just about unravelling jargon; it’s about equipping you with the knowledge to navigate the economic currents shaping our lives. I hope this explainer helps you to more confidently steer through these economic waters and traverse the complexities of our financial world.