Macroeconomics - L18 Monetary Policy Flashcards
What are the 3 objectives of monetary policy as set out in the Reserve Bank Act 1959?
Stability of the currency (low inflation b/w 2-3%)
Maintenance of full employment (U/e b/w 4-4.5%)
The economic prosperity and welfare of the people (SSEG b/w 3-3.5%
What 5 indicators does the RBA use to make decisions relating to the cash rate?
Trends in inflation
Levels of national spending and confidence
Labour market conditions
Budgetary policy stance
International developments
If inflation is high, would the RBA be likely to increase or decrease the cash rate? Why?
Increase.
This is because the RBA wants to discourage consumer spending (C) so that prices don’t continue to rise.
By increasing interest rates, consumer spending will slow due to the higher cost of borrowing, production will slow and unemployment will increase meaning that less people have a disposable income to spend on goods and services.
If consumer confidence/sentiment is low, would the RBA be likely to increase or decrease the cash rate? Why?
Decrease.
This is because the RBA wants consumers to feel confident about the state of the economy and their own personal financial situation and job security.
By decreasing interest rates, consumers will feel more confident about borrowing money to spend on goods and services. The increase in spending (C) will see an increase in production and a decrease in unemployent.
Labour market conditions are an indicator used by the RBA when making decisions about the cash rate.
A high unemployment rate indicates that there is plenty of spare capacity in the labour market and labour / skills shortages are unlikely to occur. This means there is no danger to levels of AD increasing too rapidly (via C and I).
If the unemployment rate is high, would the RBA be likely to increase or decrease the cash rate? Why?
Decrease.
This is because the RBA wants to encourage consumers to borrow money to spend on goods and services which will in turn result in increased economic activity and production. Producers will need more workers to meet the demand and this will help to reduce the high unemployment rate and utilise the spare capacity in the labour market.
If the Federal Treasurer takes an expansionary stance with the Federal Budget, would the RBA be likely to increase or decrease the cash rate? Why?
Decrease.
If the federal treasurer hands down an expansionary budget, a budget deficit (expenditure > receipts), it indicates that the federal government is trying to stimulate the economy and get consumers spending on goods and services.
Therefore, the RBA is likely to decrease the cash rate to reduce the cost of borrowing money to spend on goods and services to assist the government in achieving its goals for domestic stability.
If the GDP of Australia’s major trading partners is high, would the RBA be likely to increase or decrease the cash rate? Why?
Increase.
If the GDP of Australia’s major trading partners is high, those countries are more likely to want to purchase Australian exports and demand for the Australian dollar will go up (because they will need to purchase Australian exports in Australian dollars). This indicates that there is more money flowing into the Australian economy, in particular to exporting businesses (eg. the mining industry). This will mean greater spending (C) and (I) and strong economic growth. However the growth may not be sustainable and there may be inflationary pressures.
Therefore, the RBA is likely to increase the cash rate to ensure that the growth stays within the sustainable range of 3-3.5% and to ensure that the currency remains stable (low inflation of 2-3%).
