monetary policy Flashcards
what is monetary policy?
those actions taken by the Reserve Bank of Australia to affect monetary and financial conditions in the economy by affecting the price of money and credit
what does monetary policy involve?
setting the interest rate on overnight loans in the money market (cash rate)
what is the aim of monetary policy?
aim of MP is to help achieve sustainable growth in the long run by controlling inflation
what are the objectives of the reserve bank?
the sustainability of the currency (price stability or low inflation)
the maintenance of full employment (low unemployment); and
the economy prosperity and welfare of the people
what are the effects of high inflation?
increases uncertainty
redistributes income
encourages investment in non-productive assets
erode value of savings
undermine value of currency
decrease international competitiveness
often associated with high unemployment and a stagnant economy
higher interest rates which prevent private sector spending and lowers economic growth
what are the benefits of low inflation?
maintains the real value of money protects the value of savings keeps nominal interest rates low promotes productive investment reduces uncertainty which promotes long term growth promotes international competitiveness improves decision making
what is the financial sector?
the intermediary between savers and investors
what are the types of financial markets?
loan, bond, share
what are interest rates?
represent the price of credit - a payment from borrowers to lenders for the use of funds
what is the cash rate?
cost of overnight loans and is the main tool which the RBA uses to affect the monetary and financial conditions in the economy. The cash rate affects the interest rates which is a key instrument in either slowing down or increasing domestic investment
what will the rba do to the cash rate in an upswing/boom?
enter the money market to create a shortage of cash
increase the price of cash (the cash rate)
will cause other interest rates to rise
higher interest rates means that the price of borrowing money rises then the demand for credit will contract and private sector spending in the economy will fall
contractionary/tight monetary policy stance
what will the rba do to the cash rate in a trough/recession?
create surplus of cash which will reduce the cash rate
place downward presser on interest rates charged on loans by banks and other financial institutions
cost of borrowing will fall, the demand for credit will rise
spending and economic activity will increase
expansionary/easy monetary policy
when will the rba raise the cash rate?
the economy is growing too fast (EG > 4%)
actual GDP is above potential GDP
unemployment is below the natural rate (UE > 5%)
inflation is above the target range ( I > 3%)
the economy is hit by a positive aggregate demand shock
when will the rba lower the cash rate?
the economy is growing below the long run average rate of growth (EG < 3%)
actual GDP is below potential GDP
unemployment is above the natural rate (UE > 5%)
inflation is below the target range (I < 2%)
the economy is hit by a negative aggregate demand shock
what is neutral monetary policy stance?
consistent with the cash rate being around 4%
what is expansionary monetary policy?
RBA will adopt an expansionary stance when the economy is hit by a negative aggregate demand shock causing real GDP to contract, the price level to fall and the unemployment rate to rise
what is contractionary monetary policy?
RBA will adopt contractionary monetary policy stance when the economy is in a boom
what affect will lower interest rates have?
encourage both households and firms to increase their borrowing to help increase spending
cause the AUD to depreciate due to reduce foreign investment and capital cash flow
this will help to raise net exports
AE will rise in the economy which will help to boost the economy’s growth rate
real GDP and economic activity will expand
price levels will rise, inflation rises
what affect will higher interest rates have?
discourage households and firms from increasing their borrowing and help reduce their spending
will attract capital inflow, increasing the demand for the AUD and causing AUD to appreciate
this will reduce net exports
AE will fall as consumption, investment and net exports fall
real GDP and economic activity will contract
what are the strengths?
flexible
greater political neutrality
effective in a boom
more effective with a free exchange rate
what are the weaknesses?
less effective during a recession
suffers from time lags
affects everyone in the economy
more effective when employed to slow the economy than it is to stimulate it.
what has been the contemporary monetary policy?
monetary policy stance over the past three years (2014-206) has been expansionary
economy recovering from the end of the mining boom and collapse of the ToT
