Chapter 13 - Monetary policy in action

Question 1

What is the primary focus of the RBA?

Answer 1

The RBA is focused on the economic prosperity and welfare of all Australians by seeking to achieve a rate of inflation, on average, of 2-3% over the economic cycle.

Question 2

What are leading indicators of economic activity?

Answer 2

Leading Indicators of economic activity: loan approvals and such provide an indication of what is likely to happen to economic growth or inflation in the future.

Question 3

What are ​Lagging Indicators of economic activity?

Answer 3

Lagging Indicators of economic activity: statistics such as unemployment (rate) provide an indication of what has already happened to economic activity.

Question 4

What are Coincident Indicators of economic activity?

Answer 4

Coincident Indicators:​ such as retail sales, reflect the current level of economic activity

Question 5

What does pro-cyclical ​mean?

Answer 5

contributing to the current movement in the economic cycle

Question 6

Why is low inflation a pre-condition for the achievement of economic growth

Answer 6

To achieve a strong and sustainable rate of economic growth monetary policy must be used to achieve the goal of 2-3% inflation. This is because inflation is seen as a pre-condition to the achievement of higher growth in real GDP and employment. Low inflation stimulates AD by;

• an increase in consumption demand due to an increase in purchasing power over goods and services
• an increase in consumer and investor confidence due to greater certainty about future price changes which helps to stimulate consumption and investment demand
• an increase in international competitiveness of Australia’s traded goods sector (assuming overseas inflation rates are higher) working to boost demand for exports

Question 7

Monetary policy and short-term stabilisation

Answer 7

During periods of very low growth (or recession), the RBA is likely to adopt a more expansionary stance and loosen monetary policy in an effort to stimulate AD, real GDP and employment.

Question 8

Monetary policy and living standards

Answer 8

It should be clear that the RBA’s ultimate objective is to improve the economic prosperity and welfare of the people of Australia. This means that every single monetary policy decision is ‘designed’ to improve the living standards of Australians in the longer term.

Question 9

Specific monetary policy changes over the last 4 years.

Answer 9

• 2012-13 (4.25%-2.5%)
  
  • inflationary pressures largely absent
  • below-trend rate of growth in the economy (weaker global environment, low confidence, lower commodity prices)
• 2014 (2.5%)
  
  • expansionary monetary policy
  • inflationary pressures under control
  • economic growth below trend (fiscal consolidation, low confidence levels, falling Terms of Trade)
• 2015 (2.5%-2%)
  
  • historically low interest rates
  • higher leverage (household debt) making lower interest rates less effective
• 2016 (2%-1.5%)
  
  • ​​slight economic growth increase & unemployment drop
  • low oil price, slight rebound in commodities, lower savings rate, positive wealth effect from higher property prices
  • lower mining investment, slow growth overseas, spare capacity & overvalued exchange rate caused further lowering of cash rate.

Question 10

RBA intervention in foreign exchange market

Answer 10

The most recent occasion when the RBA significantly intervened in the foreign exchange market was 2008. At a low of $0.60USD, the RBA believed that is was well below its fundamental value. The RBA purchased $3.8B Australian dollars to stem the decline and restore confidence in the value of the currency.

Question 11

The relationship between monetary policy and budgetary policy in the management of AD.

Answer 11

In the event that the economy is experiencing stagflation (high inflation and low growth), it is likely that the RBA will tighten monetary policy to control inflation and the government will adopt a more expansionary budgetary policy stance to stimulate growth and reduce unemployment. Unless the budgetary policy initiatives are supply-side in nature, this policy combination is likely to be incompatible as tighter monetary policy will be working against expansionary budgetary policy.

To the extent that tighter monetary policy achieves the RBA’s low inflation goal over the medium term, it should be compatible with expansionary budgetary policy over the longer term as low inflation stimulate AD and economic growth.