4. Economic Policies - Monetary policy

Question 1

Goals of monetary policy

Answer 1

• Price stability
  Consumer price inflation of 2-3% on average over the economic cycle
• Full employment
  NAIRU of 4-5% (5-6%) of the labour force
• Economic growth
  Sustainable economic growth of 3-4% over the economic cycle

Question 2

Monetary policy stances

Answer 2

1 - Contractionary stance or tightening of monetary policy
2 - Neutral stance, where interest rates remain unchanged
Or
3 - Expansionary stance, or loosening/easing of monetary policy

Question 3

contractionary stance for monetary policy

Answer 3

A contractionary stance is adopted when the cash rate is increased in order to slow down the economy and reduce inflation.

Question 4

expansionary stance for monetary policy

Answer 4

An expansionary stance is adopted when the cash rate is decreased, in order to stimulate economic activity and raise employment (lower unemployment)

Question 5

What is monetary policy

Answer 5

Changing interest rates

Question 6

What is the primary mode to conduct monetary policy

Answer 6

The primary mode for changing interest rates is through the cash rate.

Question 7

What is the cash rate

Answer 7

The Cash rate is the interest paid on overnight loans in the cash market (Between banks).

Question 8

How does the RBA influence the cash rate

Answer 8

The RBA influences the cash rate by buying or selling Commonwealth Government Securities (CGSs)

Question 9

How many banks have ESAs (and for what)

Answer 9

There are around 50 banks or other financial institutions who have Exchange Settlement Accounts with the RBA, for settling overnight debt transactions.

Question 10

Contractionary stance transaction

Answer 10

RBA —> Exchange settlement accounts sell CGSs to the banks
= $ to decrease

Question 11

Expansionary stance transaction

Answer 11

RBA buys CGSs from the banks = $ to increase

Question 12

What is the interest rate corridor

Answer 12

The interest rate corridor is defined as a floor and ceiling around the cash rate in the Australian cash market (overnight market)

Question 12

What is the interest rate floor

Answer 12

The FLOOR is the RBA’s deposit rate MINUS 0.25% on any excess ESA balances that banks deposit in the RBA

Question 13

What is the interest rate ceiling

Answer 13

The CEILING is the RBA’s lending rate PLUS 0.25% on any ESA balances banks borrow if they need to cover any shortfalls in cash.

Question 14

What is the transmission mechanisms

Answer 14

The ‘transmission mechanism’ refers to how changes in interest rates reflect throughout the economy.