Monetary Policy Flashcards
Outline the role of the financial sector
Financial markets are intermediaries between savers and investors, or lenders and borrowers of funds. Most financial institutions borrow from individuals or firms with excess funds and lend to those who need funds
Explain why a stable financial system is important to the economy
Because of its role in providing finance - money and credit facilitate transactions between buyers and sellers, and enable savings to be converted into investment. Investment is key in promoting economic growth and increasing living standards over time. The financial sector is also important because it is linked to every sector of the economy and is crucial in sustaining economic growth
What do interest rates represent? What is the cash rate?
Interest rates represent the price of credit which is a payment from borrowers to lenders for the use of funds. The cash rate is the nation’s official interest rate
Distinguish between nominal and real interest rates
Nominal - rates not adjusted for inflation.
Real - adjusted for inflation = nominal - inflation rate
List the three objectives of monetary policy
Stability of the currency
Maintenance of full employment
Economic prosperity and welfare of the people of Australia
Distinguish between the headline and underlying rate of inflation
Nominal interest rates are headline rates that are not adjusted for inflation
The real interest is the nominal rate - the rate of inflation
Explain the meaning of an ‘expansionary stance’ in monetary policy
A downward movement over a period of time of the cash rate
Briefly describe the four channels in the monetary policy transmission mechanism
Cot of borrowing - higher rates increase the cost of borrowing, demand for loans from households will fall
Cash flow - rising interest rates will reduce the cash flow of households and firms
Asset prices - rising interest rates reduce asset prices
Exchange rate - If Australian rates rise above overseas rates, the currency will appreciate
Explain the influence of a change in interest rates have on the exchange rate
Changes in interest rates impact on exchange rates because financial capital is highly mobile. If AU rates rise above overseas rates, capital inflow will increase demand for the currency and lead to an appreciation. A higher AUD will reduce aggregate demand because the competitiveness of exports in overseas markets falls, and imports become more competitive with domestic products
List three key strengths of monetary policy
Decision and recognition lags are relatively short
Flexible - decisions can be made without authorisation from parliament
The link between interest rates and the exchange rate
List three weaknesses of monetary policy
Effect lag can be long because the transmission chain can be indirect
Less effective in a contraction or trough as low interest rates can be seen as not sufficient enough to stimulate private spending
‘Blunt’ policy instrument, cannot be targeted
Provide three reasons why low interest rates may have failed to lift economic activity in Australia
Existing level of debt in the private sector - household savings fell and indebtedness increased, uncertainty caused households and business reduce their spending
Wage growth - wage growth was subdued, underemployment was increased and excess labour supply meant firms could find workers easy and pay lower wages
Australia’s exchange rate - was comparatively high over the early part of the decade, driven by the terms of trade and higher interest rates than other countries. AUD reduced exports and may have slowed growth
How does quantitative easing help to boost economic activity?
Quantitative easing is when the RBA buys government bonds on the secondary market, increasing demand for bonds in the market and their price. When the prices of bonds fall, its effectiveness falls and QE drives down interest rates. In theory, by buying government binds from banks and pension funds, the RBA increases the supply of money - pumping cash into the economy. When banks have more money, they can lend more readily to businesses and consumers, which in turn leads to greater spending and more economic activity
What is unconventional policy? List examples
Unconventional monetary policy is when tools other than adjusting the cash rate are used
Forward guidance - communication of the stance to reduce uncertainty
Asset purchases - purchase of assets from the private sector
Term funding facilities - providing low-cost, long-term funding to financial institutions at rates below the cost of most their existing funding sources
