Monetary Policy

Question 1

What does tightening the monetary policy do?

Answer 1

The upward pressure of interest rates, will cause a reduction in consumer spending, as mortgages and consumer loans increase, leading to a slow down in economic activity

Question 2

What does loosening the monetary achieve?

Answer 2

By reducing interest rates, both consumer spending and business investment will increase, boosting AD and the level of economic activity

Question 3

What are the objectives of the Monetary Policy?

Answer 3

• Sustained level of economic growth
• Maintaining a low and stable inflation
  - price stability - preserves the value or purchasing power of money over time
  - contributes to sustainable economic growth
• Reduce the level of unemployment

Question 4

What is the target level of inflation and what can affect the level of inflation?

Answer 4

• RBA has a flexible target kept between 2%-3%.
  Inflation on average is kept in target
• If wage growth is higher than labour productivity & strong growth in economic activity and reduction in U/E will be a threat to inflation if the economy reaches its supply capacity.

Question 5

What are the main economic indicators taken into account by the RBA?

Answer 5

• The inflation rate
• Wage growth
• Rate of U/E
• Rate of EG
• Interest Rates

Question 6

In what ways can the RBA implement the monetary policy?

Answer 6

1. Monetary Targeting: controlling the growth in the money supply, abandoned in the mid-1980s
2. Influencing the level of of interest rates in the economy by setting the short run cash rate, through Domestic Market Operations, as changes in the cash rate will have an influence on the general level of market interest rates in the financial sector

Question 7

What is the process when conducting a tightening of the monetary policy? - DMO

Answer 7

1. RBA will announce interest in selling Commonwealth Government Securities (CGS)
2. Banks will withdraw money from their Exchange Settlement Accounts (ESA), lowering the money supply, aka shortage in borrowable funds in the overnight money market
3. Then Cash Rate &; Interest rates will rise

Question 8

What is the process when conducting a loosening of the monetary policy? - DMO

Answer 8

1. RBA will announce interest in buying CGS
2. RBA will deposit money into ESA, increasing the money supply, aka an excess of borrowable funds in the overnight money market
3. Cash Rate and Interest Rates will fall

Question 9

What does higher interest rates do?

Answer 9

Make borrowing more expensive which is likely to deter borrowing, while lower interest rates will encourage it

Question 10

What is the Transmission Mechanism

Answer 10

Explains how changes in the stance of monetary policy pass through the economy to influence economic objectives such as inflation and EG

1) saving and investment channel
2) cash-flow channel
3) asset prices and wealth channel
4) exchange rate channel

Question 11

Explain the Transmission Mechanism during a loosening of the monetary policy

Answer 11

• Downward pressure on interest rates through DMO makes borrowing cheaper for both consumers and business, encouraging them to borrow, leading to an increase in spending and raising levels of economic activity
• Reduced interest cheapen the cost of serving loans and could lead to additional pending
• A fall in IR levels will discourage financial inflow, depreciating the currency, increasing IC
• Increase AD, will either lead to higher output and employment or will spill over into higher prices and wages if the economy is close to full employment
• Rise in aggregate spending will lead to an increase in the demand for money

Question 12

Explain the Transmission Mechanism during a tightening of the monetary policy

Answer 12

DMO putting upwards pressure on IR, dampening consumer and investment spending, resulting in a lower level of economic activity, with lower inflation and higher U/E

Question 13

What is the time lag for the monetary policy?

Answer 13

Is implemented immediately, but will take from 6-18 months before full impacts of IR changes are felt in the economy

Question 14

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

Answer 14

1. Low inflation objective
2. Inflationary expectations
3. Labour costs
4. EG and lower U/E
5. External factors

Question 15

When and how has the monetary policy been implemented in the past?

Answer 15

1980s - Contractionary
1990s - Expansioanry
2000s - Tightening
Mid 2000s - Expansionary
GFC - Loosening, cash rates to 50yr lows to 3%
2009-2011 - Neutral position
2011-18 - Expansionary, cash rate was 1.5% in 2016, now 1.25%

Question 16

What is monetary policy?

Answer 16

Monetary policy is actions taken by the RBA to influence the level of economic activity in the economy by changing the level of interest rates.

Question 17

What is the RBA’s inflation target?

Answer 17

2-3% across time (on average)