Monetary policy

Question 1

Intro

Answer 1

• i/r C and DMOs. Explain the whole thing in a contractionary stance
• o RBA influences overall interest rates through cash rate (define) in the STMM (define)
• o They enforce an IRC to set the target cash rate where the upper bound is RBA’s lending rate and the lower bound is the ESA interest returns
• o Banks must have a reserve ratio of 10%
• o Thus, because commercial banks want to maximise profits and minimise costs, the banks with surpluses of deposits end up lending to the banks with deficits at the target cash rate.
• o OMOs used to adjust the actual cash rate until it reaches the target: selling CGSs to decrease supply of loanable funds and etc.

Question 2

exchange rate channel 2019

Answer 2

• o cash rate decrease, overall interest rates decrease -> due to more negative IRD, financial inflows decrease and financial outflows increase -> decreased demand for AUD + increased supply of AUD -> AUD depreciation (DIAGRAM)
• o Cash rate was 1.0% 2019, and fed rate was 2.5%
• § F inflows decreased and F outflows increased as in 2019, Australia became a net K importer
• -> demand for AUD decreased and supply of AUD increased
• § AUD thus depreciated
• § Intl competitiveness increased from -2.7% (2015) to 1.5% (2019)
• § March 2016 inflation was 1.3%, then December 2019 inflation was 1.8%.
• o INEFFECTIVE because didn’t get back to 2-3%

Question 3

savings-investment channel

Answer 3

• S-I channel 2020 0.25%
• o TALK ABOUT LIMITATIONS OF MP. MARCH 2020, BUT JULY 2020 RECESSION HAPPENED. INEFFECTIVE
• o June 2020 Inflation -0.3% due to low consumer confidence (decreased C and I)
• o RBA set cash rate at 0.25% April (2020)-> decreased cost of consumption and investment -> meant to incentivise/stimulate spending by provoking the intertemporal substitution effect
• § (bringing consumption forward while there are low borrowing prices)
• o INEFFECTIVE due to global influences as July 2020 entered recession of -6% e/g.
• This was due to LONG ASS 6-18 MONTH TIME LAG

Question 4

quantitative easing (unconventional monetary policy)

Answer 4

• ENTERED A LIQUIDITY TRAP DUE TO NO CONSUMER NOR BUSINESS CONFIDENCE: LOW I/R MAKES NO DIFFERENCE -> thus forcing unconventional monetary policy
• o Definition: the selling of bonds in order to bring LT i/r down, when short term i/r is already extremely low
• o Stat: RBA bought $100bn worth of bonds from OMO between 11/20-2/21 then again between 4/21-2/22. (which in doing so increase S of bonds therefore LT i/r decreases )
• o This increased demand for bonds -> increased price of bonds -> decrease in LT i/r.
• o EFFECT ON ECONOMY: LT I/R ARE IMPORTANT BECAUSE THEY ALLOW FIRMS AND GOVERMENT TO TAKE OUT BIG LOANS FOR INFRASTRUCTURE AND CAPITAL EXPANSION. That’s why it’s called long term (also because infrastructure and capital expansion are aggregate supply/productive capacity expanders)
• § They help reduce bottlenecks in infrastructure and increase productive capacity: AGGREGATE SUPPLY TARGETED
• · Infrastructure bottlenecks: the current infrastructure is not built to handle the capacity of the economic activity going on

Question 5

asset price channel 2020 and forward guidance 2021

Answer 5

• Asset-price channel 2020 0.1 and forward guidance 2021???
• o Wanted to increase inflation
• o i/r decreased -> decreased cost of borrowing for mortgages-> increased demand for assets -> increased consumption and investment for houses -> increased demand-pull inflation
• o forward guidance: 2021 philip quote of the year -> tried to spark investment and consumption
• o LED TO HOUSING BOOM (4 year thing ask xerxes)
• o Limitation: Blunt instrument: this led to DOW worsening because assets increased in price!

Question 6

cash flow recent hikes 2023

Answer 6

• To decrease consumption: consecutive hikes in 2022 from April (0.25%) to December (3.10%) pushed e/g down to 2.7% (lower than the GOVT’s goal of 3-4%)
• § Therefore it was too strong
• § At the same time it was INEFFECTIVE because of supply chain issues with China’s lockdown which were pushing cost-push inflation.
• § Indeed, cost push inflation went to 7.8% in December 2022

Question 7

limitations

Answer 7

• Effective at high levels of inflation
• Struggles to achieve multiple goals - but keeping interest rates low (first goal) helps other goals
• IF governments control: Can be distorted by political pressures (esp. During elections when politicians want interest rates to be low)