Monetary Policy

Question 1

Define monetary policy

Answer 1

Actions by the RBA to influence the cost and availability of money in the economy 
Used to: 
- smooth fluctuations in BC 
- influence level of EA 
- influence employment and prices

Question 2

Describe the domestic market operations instrument

Answer 2

Main tool of MP - influences the level of IR in the economy

- Actions influence market IR - helps it achieve its objectives relating to EG, IF and UE

Question 3

Outline the objectives of monetary policy

Answer 3

• Stability of the AUD (maintaining low IF and reducing fluctuations in value of AUD)
• Maintenance of full employment
• Promoting economic prosperity and welfare (encouraging sustained level of EG)
• Recent years - primary focus has been low inflation

Question 4

Outline the TWO possible instruments for implementing monetary policy

Answer 4

• Money Supply - monetary targeting through RBA’s control over the money base
• Interest Rates - setting the short run cash rate - rate setting MP

Question 5

Explain the process of buying and selling securities

Answer 5

Buys securities > pays by depositing money in the sellers ER settlement account (ES) > adds to total ES balance > increases S of settlement funds > downward pressure on cash rate

Sells securities > withdraws money from ES account > taking away from total ES balances > decreases S of settlement funds > upward pressure on overnight cash rate

Question 6

Outline the effects of a change in interest rates on economic activity and the exchange rate

Answer 6

• Changes to demand for credit

Higher IR> borrowing more expensive> deters borrowing

Lower IR > encourage borrowing

• TRANSMISSION MECHANISM

Question 7

What is the transmission mechanism?

Answer 7

Explains how changes in the stance of MP pass through the economy to influence eco objectives i.e. IF and EG

Question 8

What are the 5 main factors that help explain the stance of monetary policy?

Answer 8

Acronym: LILEE

• Low inflation objective > Aus will achieve higher EG in the LT by raising IR when there are rising inflationary pressures
• Inflationary expectations > If IE remains low, bizs will plan lower price increases
• Labour costs > RBA states that wage growth must remain below 4.5% to be consistent w/ inflation target
• EG and lower UE > if eco is operating close to its capacity, continued EG will spill over into inflation - likely to tighten MP when UE is near NAIRU
• External factors > huge impact on TOT, Y levels, EG and UE - responds with higher IR