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Monetary policy Flashcards

1
Q

What is monetary policy? 5

A

demand management tool - macro
- refers to actions taken by the RBA to affect monetary and fiscal conditions in the economy by affecting the price and money of credit
- involved setting the cash rate which is the interest rate on overnight loans in the short term money market
- setting o cash rate by RBA impacts market interest rates which indirectly aects levels of AD in economy
- therefore demand management policy used to stabilise economic activity

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2
Q

What are interest rates? 2

A
  • represent the price and/or cost of money and credit
  • when RBA changes cash rate, change flows through to other IR and can have an important effect on employment , output and prices
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3
Q

What is nominal I/R?

A
  • I/R not adjusted for inflation
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4
Q

Real I/R and equation

A
  • takes into account inflation, remove inlation rate so real income earned on credit can be determined
  • Nominal I/R - inflation rate = REAL I/R
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5
Q

What 5 causes changes in I/r flunctuaties

A
  • due to changes in demand and supply for loanable funds
    causes:
  • level of economic activity
  • public sector debt
  • level of savings
  • RBA monetary policy
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6
Q

Cash rate? 3

A
  • investment is known ar cashr ate -> I/R on overnight loans from the RBA to banks
  • interest rates the price of money (cost of credit)
  • price of credit is determined by the market 0> demand for loanable funds represents he lenders
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7
Q

Loanable funds AD/AS

A
  • Supply (SLF - supply loan funds)
  • Demand (DLF - demadn loan funds)
    -I/R, QE at equil
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8
Q

What are the three stances of monetary policy (operation of MP)

A

Contractionary (tight mp)
- increase I/r
Expansionary (easing mp)
- decreasing I/r
Neutral on mp
- no change to I/r (moderate i/r)

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9
Q

What are open market operations?

A

describes the actions by the rba to intervene in the short term money market in order to maintain or change the cash rate as determined by the stance on monetary policy

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10
Q

What are ESAs? 5

A
  • exchange settlement accounts
  • all banks have an account within the RBA known as ESA
  • these accounts consists of exchange settlement funds (ESFs)
  • are the funds banks use to settle their transaction with each other
  • ESAs must be in surplus all the time
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11
Q

What is the short term money market? 3

A
  • involves deamnd for overnight loans (banks) and the supply for overnight loans (RBA)
  • if banks have insufficient funds to settle their transactions with other banks, they must borrow a short term loan(overnight loan) from the RBA
  • interest rate charged on overnight loans is known as cash rate
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12
Q

AD/AS for overnight loans

A
  • Supply curve is vertical and demand curve id diagonal
  • equilibrium CR,QE
  • price for overnight loans is determined by the equilibrium at Cash rate
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13
Q

AD/AS model overnight loans for maintaining cash rate: increase in demand

A
  • an increase in demand foir overnlight loans from D to D1 creates a shortage (QD>QE) of ESFs in the short term money market
  • this puts pressure in the cashr ate to rise
  • in order to prevent this, the rba will increase supply to S1 in order to to remove the shortage to maintain cash rate at CR
  • will increase the supply funds thru the purchasing of bonds from banks.
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14
Q

AD/AS model overnight loans for maintaining cash rate: decrease in demand

A
  • an decrease in demand foir overnlight loans from D to D1 creates a surplus (QD<QE) of ESFs in the short term money market
  • this puts pressure in the cashr ate to fall
  • in order to prevent this, the rba will decrease supply to S1 in order to to remove the surplus to maintain cash rate at CR
  • will decrease the supply funds thru the selling of bonds from banks.
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15
Q

AD/AS model overnight loans for cashin rate: increase in cash rate

A
  • contractionary stance
  • an increase in cash rate foir overnlight loans cause supply to increase to S1,
    -will increase the supply funds thru the purchasing of bonds from banks.
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16
Q

AD/AS model overnight loans for cashin rate: decrease in cash rate

A
  • expnasionary stance
  • an decrease in cash rate foir overnlight loans cause supply to increase to S1,
    -will decrease the supply funds thru the selling of bonds from banks.
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17
Q

What is conventional monetary policy? 3

A
  • refers to the standards tools used by central banks to achieve economic objectives and stability econ activity by adjusting interest rates, controlling inflation, employment and economic growth
  • use of cash rate to achieve 3 econ objectives
  • transmission mechanism
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18
Q

What is unconventional monetary policy?

A
  • refers to tools such as forward guidance, asset purchases, term funding facilities, adjustments to market operations, negative interest rates to achieve economic objectives
  • makes it cheaper or easier to withdraw/spend/lend money
  • refers the Rba reducing I/R without the use of cash rate
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19
Q

5 unconventional monetary policy tools

A
  • forward guidance
  • quantative easing (asset purchases)
  • term funding facilities
  • adjustment to market operations
  • negative interest rates
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20
Q

What is forward guidance?

A
  • A strategy used by RBA to influence expectations about I/R to increase investor confidence, to spend more or less
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21
Q

What is quantative easing (asset purchases)? 6

A
  • refers to RBA purchases of financial assets to increase demand for bonds and share prices.
  • YIELD= eturn on investment
  • in regard to bond market(loan market) quantitative easing aims to reduce the interest on loas (reduce the yield)
  • Rba will enter market as a buyer and purchase (lend) bonds, increasing price of them
  • resulting In decrease in yield( earnign same interest but less percentage of the price)
  • shows why QE support lower I/R, making git cheaper for firms to lend
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22
Q

What is term funding facilities?

A
  • a program that provides low cost, long term funding to banks, encouraging lending to businesses and h/h
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23
Q

What are the 3 objectives of monetary policy in order

A
  • the stability of the economy of aus
  • the maintenance of full employment in aus
  • the economy prosperity and welfare of the people of aus
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24
Q

What is the transmission mechanism?

A
  • refers to how changes in the cash rate influences economic decisions of households, firms and overseas which will affect AE, AO, employment and inflation
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25
Q

What are the four channels of transmission mechanism

A
  • cash flow
  • savings and investment
  • wealth and assets
  • exchange rates
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26
Q

How does an increase in cash rate affect cash flow? 4

A
  • decreases cash flow
  • increase mortgage payments and interest incurred from other form of credit
  • reduces disposable income for h/h
  • firms also have reduced cash flows as payments on existing debts increase.
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27
Q

How does an increase in cash rate affect savings and investment 7

A
  • cost of borrowing increases
  • LENDERS (SAVINGS)
  • increse in savings
  • represents an rise in rate of return therefore encourages firms and h/h to save -> decreasing consumption and investment
  • BORROWERS(INVESTMENT)
  • investment falls
  • h/h and firms less likely to borrow as the cost of the loan increases -> decreasing consumption and investment
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28
Q

How does an increase in cash rate affect wealth and assets? 6

A
  • decrease in wealth and assets
  • encourages firms and h/h to spend less
  • interest rate changes affects the rate of return on a type of investment, and this impacts the demand for alternative types of investment
  • rise in cash rate results in higher rate of return for investors in the loan market rather than in shares or property market
  • decrease in investors buying shares decreases D to D1, causing price to decrease to PE1.
  • results in decrease in the value of wealth and assets, encouraging both h/h and firms to decrease spending
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29
Q

How does an increase in cash rate affect exchange rates? 7

A
  • aud is determined by a floating exchange rate, therefore change to i/r will affect aud market
  • increase Fi as increase in rate of return
  • increase in demand for AUD causing appreciation of aud
  • decreases International competitiveness
  • demand for X Falls
  • demand for M rises
  • net exports falls
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30
Q

What are the 5 circumstances in which the RBA change the cash rate? 5

A
  • trends in aggregate demand eg consumption and planned investment
  • leading indicators of credit, consumer and business confidence
  • price indices, including underlying and headline, producer and consumer prices, wage rates, import prices and house prices
  • external indicators such as ER and balance on g/s
  • other policy settings eg fiscal policy
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31
Q

4 Trends in cash rate over 2020-24

A
  • In 2020 from 0.75 to 1% by Nov 2020(Expansionary)
  • in 2021 maintained 0.1 to continue support of economy during COVID - boost h/h spending(expasnionary)
  • in 2022 I/r bgan to increase to neutral lvl of 2.5 as need for emergency has eased with opening up of borders(Contracionary)
  • in 2023 continues to increase from 3.1 to 4.35 In Nov (Contractionary)due to high inflation which is the primary objective of mp
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32
Q

3 trends in Monetary policy in the two years before pandemic

A
  • long periof of stable cash rates from aug 2016 to june 2019
  • june 2019, cash rate reduced 3 times from 1.5% to 0.75%
  • in mid 2019 rba believed that economic objectives were not being achieved
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33
Q

4 reasons why rba kept rates stable

A
  • rba believed economy was making progress towards its economic objectives
  • australias growth rate was considered reasonable
  • UE rate was moving down (5%) closer to the NAIRU
  • reducing rates may lead to increase in demand for home loans, increase in property prices and decrease home affordbility
34
Q

4 trends of Monetary policy during the pandemic

A
  • emergency measures to control COVID-19 pandemic included
  • in 2020 cash rate decrease from 0.75% to 0.1%
  • provision of formal guidance that the cash rate would still lag low
  • RBA would buy many secondhand bonds to keep the I/R to achieve a target yield on 3 year bonds
35
Q

7 Strengths of monetary policy : effectiveness

A

-Inside lags are shorter than Fiscal policy (decision, recognition, implementation)
-decision made quickly and implemented immediately with banks following through usually within the week
- more effective in peak as I/R affects cost of borrowing, investment and wealth+Assets are higher in a peak
- politically natural -> RBA is not affiliated with a political party unlike the Govternments stance of fiscal policy
- flexible as it can be adjusted to unpredicitble changes in economic conditions as it meets frequently within a year
- also adjusts changing to marking condition in the shoterm money market through open market operations
- more effective with a floating exchange rate as it allows channel to alter net exports thru the transmission mechanism

36
Q

5 Weaknesses of Mp: Effectiveness

A
  • indirect policy -> relies on transmission mechanism and indirectly affects AE
  • outside lag(effect lag) is later than FP-> takes time to filter thru the economy and is not a direct injection of funds
  • uses a blunt instrument (Cash rate) and the rba cannot be selective or target a particular section
  • less effective In a trough as it has little impact on improving consumer/investor sentiment thefore, h/h and firms nay be more inclined to save rather than spend
  • relies on banks and other financial institutes to pass the changes in the cash rate to the public in terms of their market I/R
37
Q

Short run economic growth (Actual growth) 6

A

refers to an increase in an economys output within a brief period, typically over a year
- mostly derives from cyclical and seasonal fluctuations in econ activity (business cycles)
- economic are subject to cyclical and seasonal fluctuations
- in ling run, these deviations tend to even out, leaving the underlying growth trend unchanged
- SREG generally influenced by demand side factors such as changed in consumer spending or govt policy
- short run growth might be manipulated using FP OR MP

38
Q

Using business cycle for SREG

A
  • y axis real gsp
  • x axis years
  • arrow showing expansion curve
39
Q

AD/AS model for SREG

A
  • Increase AD TO AD1
  • creating LRAS at OE1
  • increases pe to PE1
40
Q

PPF for SREG

A
  • y axis xaptial growth
  • x axis consumer growth
  • point A inside of curve pointing to point B on curve
41
Q

Long term economic growth (potential growth) 5

A
  • long run economic growth extends across a lengthy time frame, often a decade or more
  • concerns underlying trend in economic growth, excluding short term fluctuations
  • represents the economy potential productivity, incorporating elements such as technological progress, capital accumulation and improvements in labour productivity
  • long run economic growth is typically driven by supply side factors
  • long run growth is generally directed by structural reforms and investments that improve productivity
42
Q

Business cycle for LTEG

A
  • long run economic grwoth line through business cycle,
  • point a on line pointing to b also on line
43
Q

PPF cycle to LTEG

A
  • increase in PPF curve shifting outwards
44
Q

AD AS model for LTEG

A
  • Equil at PE,OE, LRAS
  • LRAS shift to right LRAS 1, increasing OE1 (FE)
45
Q

What is the 8 importance of long run economic growth

A
  • increase in quantity and quality of g/s
  • accommodates an increase in population
  • decrease in unemployment
  • increase In efficiency
  • increase in living standards
  • accommodate for growing population, keep up w demand
  • employment opportunities
  • innovation and opportunities
46
Q

4 key factors impacting long run economic growth

A

-Capital accumulation
- labour and human capital
- technological progress
- insututions

47
Q

What is Capital accumulation

A

captial includes machinery, tools and buildings that help produce g/s
- an economy with more capital per worker tends to have a higher output, driving econ growth

48
Q

What is labour and human capital?

A
  • the size of the labour force and its level of education, skills and health all conribute to economic growth
    -> better educated and healthier workers are more productive, pushing the economy output higher
49
Q

What is technological progress?

A
  • technological advancements pave the way for new and improved ways of producing g/s
  • they allow the economy to generate more output from existing resources
50
Q

What is institutions?

A
  • govt policies and social isntutuions play a considerate role in driving economic growth
51
Q

What is productivity?

A
  • relationship betweem inputs and outputs
  • increase productivity(productive efficiency) means more output can be produced with a given amount of inputs
52
Q

What is labour productvity and the equation

A
  • realtionship betweem output per hrs worked
  • output/ hours worked
  • increase in labour product ivty results in more output produced per hours worked
53
Q

How can labour productivty be illustrated

A

Aggregate productivty function
- curve is initally position sloped as inputs and outputs rise
- output will eventually slowdown and due to law of diminishing returns
- APF shifts to APF 1 shows how same amount of labour inputs can produce a higher lvl of output

54
Q

Two components of labour productivity and equations

A
  • capital deepening(increase capital to labour ratio)
    -> output/units of capital
  • multi factor productivity MFP
    -> outputs/ labour+capital inputs
55
Q

4 Labour productivity trends from 2021

A
  • fro 2021, labour productivty is falling
  • no of hours is increasing but output produced per hour is falling
  • australias labour is slower compared to other countries
  • capital deepening in the last 10 years is contributing more to labour productivity than MFP
56
Q

What is capital deepening?

A

accumulation of more capital equipment per worker = growth in Capital to worker
→ new equipment expected to embody better technology
→ More efficient equipment = increase in output which a
Worker can generate.

57
Q

What is multifactor productivity? and 6 examples

A
  • all other changes in the quantity/ quality of productive input, including:
  • increase in human capital ie the knowledge and Skills of the workforce + experience
  • research / development activity
  • improvements in management practices
  • eg. human resource management, cost control, staff declopenet
    and inventory management
  • innovation in products + productive processes
  • competition in the economy therefore promoting the entry of new innovative businesses + exit of unproductie ones
58
Q

What are the 3 major factors affecting labour productivity

A
  • PHYSICAL CAPITAL (Capital Deepening)
  • HUMAN CAPITAL
  • TECHNOLOGICAL PROGRESS
59
Q

What is physical capital and how can it affect LP

A
  • '’tools workers have to work with’’.
  • including plant and equipment used by firms
  • infrastructure such as roads, transportation networks, provided by govt
  • greater physical capital -> more output
  • can affect productivity thru:
  • increase in the quantity of physical capital(Eg more computers of same quality)
  • increase in the quality of physical capital (Eg same no of computers but computers are faster)
60
Q

What is human capital and how can it affect LP

A
  • accumulated knowledge, skills and experience that the average worker in an economy possesses
  • idlues all relevant knowledge that workers have accumulated through out their life
  • higher avg lvl of education in economy -> the higher the accumulated human capital and labour productivty
61
Q

What is technological progress and how can it affect LP

A
  • combination of invention (advanves in knoeledge) and innovation (putting that advance to use in new product or service)
  • includes new methods of organising work, for ensuring better quality of output
62
Q

How are labour productive policies different from MP AND FP

A
  • supply side policies
    -> effect is an increase in aggregate supply
  • microeconomic policy as it includes changes (or reforms) to individual sectors
    -> will lead to macro effect
63
Q

What is the aim of labour productive policies

A
  • increase productivity and efficiency
  • the objective of labour productivity is to increase output per hour worked
64
Q

7 ways govt can increase labour productvity

A
  • increase funding in education sector to increase human capital
  • increase access to higher education(subsidise cost of tertiary)
  • innovation grants to encourage research + development -> increase technological progress
  • increase access to health care
  • infrastructure funding
  • increase competiton
  • deregulation of sectord
65
Q

5 labour productivity policies of government

A
  • labour market reform
  • infrastrucutre policy
  • education and training policy
  • research and innovation
  • competition policy
66
Q

Describe labour market reform and workplace relations

A
  • Reforms introduced to remove regulations (government rules) in the labour market to increase efficiency (referred to as deregulation – removal or reduction of government regulations, or rules, in order to increase efficiency.
  • began in the 1980s
  • 2009: Labor Government introduced the “Fair Work Act”
67
Q

What did the fair work act include?

A

->Setting of minimum wage->Resolving disputes between employees and employers
->Approve Enterprise Bargaining Agreements (EBAs)
->Address cases of unfair dismissal
->Create a safety net for employees and employers
- Over the past few years, labour productivity fell. At the same time, the number of EBAs and union membership has fallen. In addition, wages have been stagnated(not grow)

68
Q

What is EBAs

A
  • EBAs outline set terms of employment for employees.
  • EBAS is an agreement between employees (or a group of employees) and employers aimed to give both sides bargaining power regarding the conditions of employment.
  • this lends itself to a happier employer which will mean a more productive employer, and will therefore produce more per hour.
69
Q

Describe the infrastructure policy

A
  • Two types of infrastructure – hard and soft.
  • Hard infrastructure refers to construction of physical capital such as roads, water supply, electrical grids, ports, telecommunications etc.
  • Soft infrastructure includes social security, education and health.
  • infrastructure of an economy will enable increasing efficiency and productivity while reducing costs of production.
    -2017-> “Infrastructure Australia” created a priority list of 100 potential nation-shaping infrastructure projects, with estimated costs of $55 billion.
  • Majority of these projects are funded by the Government, as well as Public-Private Partnerships (PPT).
70
Q

What are examples of Infrastructure projects

A
  • Inland rail between Melbourne and Brisbane
  • Electric Vehicle fast charging networks
  • Second runway at Perth Airport
  • Perth water security
71
Q

What is the education and training policy?

A
  • Human capital is a major factor influencing labour productivity.
  • Human capital refers to the knowledge, skills and experience of workers.
  • Includes both formal (certificate/qualifications) and informal education (skill development in new technology, on the job training, application of leadership skills).
  • Development in new technology is measured within capital deepening which is a major component of labour productivity.
  • 1995->the Australian Government introduced the Australian Qualifications Framework (AQF) which includes 10 qualification levels aimed to connect education qualification with industry requirements
72
Q

What are examples of the qualification levels AQF introduced?

A
  • international testing including NAPLAN to measure educational progress and allows for monitoring performance.
  • This data useful in future policy development.
  • Future policies to focus on bottom-up strategies to increase educational outcomes.
73
Q

Describe the research and development policy

A
  • Direct benefits of research and development include new and improved products, increased revenue, lowering costs of production, increased competitiveness, increased customer service.
  • Technological progress is a result of research and development and is a major factor affecting labour productivity.
  • Research includes:
    ->Basic research of fundamentals
    ->Applied research e.g. developing products and processes
    ->Experimental development
    ->Government policy can support business research and innovative activities
  • Australian innovation policy aims to provide greater support to small businesses in developing innovation in digital technology
  • Government has a range of programs to encourage an ‘innovative mindset’ and support business with advice and tax incentives. eg. National Science and Innovation Agenda
74
Q

What is the National Science Innovation Agenda?

A
  • 2015->the National Science and Innovation Agenda was announced
  • committed $1.1 billion over four years and 24 measures focused on science, research and innovation
  • The Commonwealth Scientific and Industrial Research Organisation (CSIRO) fund enables start-ups, SMEs, and researchers to more successfully bring their innovations to life through funding, programs, and commercialisation assistance.
75
Q

Describe the competition policy?

A
  • Increased competition forces businesses to increase productivity, including labour productivity, to become more competitive.
  • ACCC (Australian Competition and Consumer Commission) is responsible for the administering the Competition and Consumer Act of 2010.
76
Q

What was the purpose of the ACCC?

A
  • purpose of the Act is to promote fair trading and competition.
  • This includes:
    ->Maintain and promote competition
    ->Promote efficient operation of infrastructure
    ->Undertake studies to increase competition
    -2018->The Competition and Consumer Act passed amendments to increase innovation, entrepreneurship, clarity in competition laws, and the fostering of diversity in the market.
77
Q

Effect of labour productivity on economy AD/AS model

A
  • Economy before labour producivity operating at PE, O(FE) (LRAS, SRAS AND AD)
  • Both LRAS AND SRAS increase due to an increase in the productive capacity of economy
  • now currently operating at O(FE1) AND PE1.
  • increases standard of living and in real income
78
Q

Effect of labour productivity on economic growth

A
  • increases from O(FE) to O(FE1) as productive capacity of the economy, resulting from more output being produced per hour worked, increases.
  • represents long run economic growth as growth is driven by the increase in efficiency of labour inputs which Is supply source of growth
79
Q

Effect of labour productivity on unemploymet

A
  • Long run economic growth increasing labour productivity creates more job opportunities and therefore reduces unemployment without inflationary pressure.
  • therefore the NAIRU reduced due to increase in productive capacity
  • the full employment rate is revised to a lower per cent
  • in the short term, it can create structural UE as now labour is used in production, as well as the introduction of new capital
  • this changes the demand for workers skills
80
Q

Effect of labour productivity on inflation

A
  • inflationary pressure eases as price falls from PE TO PE1
  • increase in labour productivity reduces the average cost per unit if output
  • the costs of producing falls (Decrease in cost push inflation)
81
Q
A

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