Monetary Policy

When the RBA, on the governments behalf, influences the cash rate and subsequently general interest rates.

Main macroeconomic tool to regulate aggregate demand and economic activity (GDP growth).

Countercyclical – swing arm of policy

RBA long-term goals

Financial stability

Full employment

Increased prosperity

Inflation Target

RBA medium term goal of price stability is inflation in the 2%-3% range over the course of the economic cycle.

WHY?

Low inflationary sustainable economic growth

Pre-emptive policy

The RBA not only considers the current inflation rate and the state of the economy it will also consider all economic indicators that can influence future inflation

eg

Implementing Monetary Policy

The RBA announces its intention to alter the cash rate. This informs the financial markets that the RBA is altering its stance.

The cash rate is the interest rate paid on funds in the overnight money market. The cash rate is determined by the supply of money and the demand for overnight money.

More implementing MP

Financial Institutions hold funds in their exchange settlement accounts to complete daily transactions between each other and the RBA.

By manipulating the supply of funds in the overnight money market the RBA can control the cash rate.

easing, loosening, expansionary stance

RBA purchases second hand CGS from financial institutions (domestic market operations)

This increases the supply of funds in the ES accounts and reduces the cash rate.

Financial institutions will now have excess liquidity in ES accounts and will attempt to lend this money to businesses and the public.

easing, loose, expansionary

To attract potential borrowers the financial institutions will lower general interest rates.

Investment and Consumption will both increase causing a rise in aggregate demand

In the medium- term the economy will expand as increasing aggregate demand causes growth in output, employment and national income.

Expansionary Monetary Policy is attempting to increase the rate of growth of the economy and the money supply by increasing the velocity of circulation of money

What is the current cash rate? Draw transmission mechanism

tight or contractionary stance

Explain how it works and draw Keynesian diagrams to illustrate the transmission mechanism

Note: Tight Monetary Policy attempts to slow down the growth of the economy and the money supply by slowing down the velocity of circulation of money

International factors

Low international interest rates due to GFC 2014/Fed Funds Rate is now 0.25% Uncertainty on global markets

Effectiveness

Long and Variable Lag Exchange Rate Effects Blunt Instrument Wages Growth International Shocks

Future Issues

Strength of World Growth Comparative interest rates Exchange rate Domestic Capacity Constraints Industrial Relations System and wagesgrowth