Monetary Policy Flashcards
What is Monetary policy
Monetary policy can be defined as central bank actions to manipulate the price and availability of credit in the economy
What is the Cash Rate
The cash rate is the interest rate charged on overnight loans between banks.
what are the objectives of the RBA
- The stability of the currency of Australia
- The maintenance of full employment in Australia
- The economic prosperity and welfare of the people in Australia.
The Monetary Decision process (what the RBA will consider)
- Domestic economic conditions
- International economic conditions
- Financial Markets – Bond market, share market
what is Australia’s inflation target
2-3%
Why does the Reserve bank target inflation?
If inflation is too high
• Consumers purchasing power is reduced
• Workers may then seek larger wage increases to compensate for the effects of higher inflation
• Spending and investment decisions may be distorted
• Returns on investment may be lower
If inflation is too low
• Consumers may delay purchases if they expect prices to fall equating to lower spending
• Businesses facing difficult conditions may find it hard to reduce the real wages of their employees and may resort to laying off workers instead.
How does the inflation target work?
- Monetary policy aims to keep inflation between 2 and 3 per cent, on average, over time, in support of the Reserve Bank’s goals of price stability and full employment.
- The cash rate is used to dampen or stimulate economic activity so that inflation is consistent with the target.
- When inflation is above the target, this can be a sign that the economy is overheating.
- When inflation is below the target, this can be a sign that the economy has spare capacity
- The RBA would typically increase the cash rate if inflation is expected to be higher than the target for a sustained period of time.
- The RBA would typically lower the cash rate inflation is expected to be lower than the target for a sustained period of time.
Why the target of 2-3%
- It’s sufficiently low so that inflation does not significantly influence people’s economic decisions.
- At this level a country can achieve sustainable economic growth in output and employment
Why is the inflation target flexible?
- This means that it does not have to be in the target range at all times
- This allows the RBA to consider its broader objective of employment and financial stability
How well have we met the inflation target?
- Since the early 1990s the rate of CPI inflation has been within the target range and expectations of inflation
- Since the inflationary target was introduced low and stable inflation has reduced uncertainty in the economy and has underpinned economic growth.
what are the two stages of the transmission mechanism
- Changes to the cash rate flow through to other interest rates in the economy
- Changes to these interest rates affect economic activity and inflation.
what are the channels of Monetary Policy Transmission
Saving and Investment Channel
Cash Flow Channel
Exchange rate channel
Asset Prices and Wealth Channel
The Strengths of Monetary Policy
- Flexibility – can be changed bit by bit, month by month
- RBA independent of government – political neutrality
- Works OK in slowing economy in a boom
- More powerful now debt levels high
The Weaknesses of Monetary Policy
- Doesn’t work well in getting economy out of a recession (e.g Japan, US)
- Long effect lag
- Controlling demand can cut aggregate supply (by reducing investment).
What are the characteristics of Expansionary Monetary Policy
- Lower Cash rate
- More aggregate expenditure
- Stimulates the economy
