(t4) monetary policy

Question 1

What is monetary policy (MP)?

Answer 1

MP involves actions by the RBA to influence credit costs and availability, impacting economic activity, employment, and prices.

Question 2

Who controls MP in Australia?

Answer 2

the RBA controls MP independently

Question 3

How does the RBA influence interest rates?

Answer 3

The RBA sets a target for the cash rate (overnight interest rate) and uses open mkt operations (OMOs) to influence overall interest rates in the economy.

Question 4

What are open mkt operations (OMOs)?

Answer 4

OMOs are actions taken by the RBA to buy or sell govt securities in the financial mkt to control the supply of money and influence the cash rate (overnight interest rate).

Question 5

What is contractionary MP?

Answer 5

Contractionary MP is when the RBA raises interest rates, reducing spending and investment, slowing down eco activity, and lower inflation.

Question 6

What is expansionary MP?

Answer 6

Expansionary MP is when the RBA lowers interest rates, boosting spending, investment, eco growth, and inflation.

Question 7

What are the main objectives of MP according to the Reserve Bank Act of 1959?

Answer 7

1. to maintain the stability of Australia’s currency
2. support full employment
3. promote the economic prosperity and welfare of Australians.

Question 8

What is meant by “inflation targeting”?

Answer 8

the RBA’s approach to keeping inflation within a target range of 2-3% to maintain price stability.

Question 9

Why does the RBA prioritise inflation stability over other goals?

Answer 9

Price stability makes the economy more predictable and reduces political influence on interest rates, supporting long-term growth and lower unemployment

Question 10

How does the RBA achieve its inflation target when inflation is high?

Answer 10

The RBA raises interest rates which reduces spending and borrowing, slowing down the economy and lowering inflation.

Question 11

What was a key outcome of the 2023 review of the RBA?

Answer 11

The review recommended that the RBA focus on a ‘dual mandate’ of price stability and full employment, clarifying its goals.

Question 12

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

Answer 12

inflation, expectations of future inflation, waged growth, unemployment rate, eco growth, interest rates, exchange rate, commodity prices, ToT, global economic conditions

Question 13

What is the primary tool the RBA uses to implement MP?

Answer 13

the cash rate

Question 14

What is the cash rate?

Answer 14

The interest rate for short-term loans between banks and influences other interest rates in the economy, impacting inflation and eco activity.

Question 15

How frequently does the MP board meet to set the cash rate target?

Answer 15

8 times a year

Question 16

What are Exchange Settlement (ES) Accounts?

Answer 16

ES accounts are accounts that banks hold at the RBA to settle interbank transactions

(when a customer from bank A makes a purchase from a business using bank B, ES accounts allow funds to transfer easily between the banks)

Question 17

What is the overnight money mkt?

Answer 17

A mkt where banks borrow and lend ES funds, depending if they have a shortage or surplus of funds) for short-term needs.

Question 18

What is the policy rate corridor?

Answer 18

A range set by the RBA to keep cash rate close to its target. The target is trapped in between a deposit rate (floor) and a lending rate (ceiling) which are both 0.25ppt below and above the target.

Question 19

How does the RBA use Domestic Market Operations (DMO) to manage the cash rate?

Answer 19

The RBA buys or sells govt securities to manage the supply of ES funds and maintain the cash rate near the target. Buying increases ES funds while selling decreases ES funds.

Question 20

What is the purpose of the cash rate in relation to other interest rates in the economy?

Answer 20

It anchors other interest rates as it influences how much it costs financial institutions to fund themselves, affecting rates on loans and mortgages.

Question 21

What are unconventional MPs?

Answer 21

Policies beyond standard interest rate changes, like asset purchases and forward guidance, when traditional rate adjustments are not enough.

Question 22

What is the yield curve, and how does unconventional MP affect it?

Answer 22

The yield curve shows interest rates for different loan maturities, usually higher for longer terms. Unconventional MP often flattens this curve, lowering long-term interest rates without affecting short-term ones as much,

Question 23

What is forward guidance as used by the RBA?

Answer 23

A communication strategy to signal future MP, influencing current long-term interest rates.

Question 24

What is the transmission mechanism in MP?

Answer 24

The process through which changes in the MP affect the economy, impacting objectives like inflation and eco growth. (a ripple effect)

Question 25

How does lowering interest rates encourage consumer business borrowing

Answer 25

It makes borrowing cheaper, leading to increased demand for loans by consumers and businesses for purchasing and investing.

Question 26

What is the ‘cash flow channel’ of MP?

Answer 26

When loan payments become cheaper for existing borrowers when interest rates drop, freeing up their income for other spending.

Question 27

How does a lower interest rate affect the exchange rate?

Answer 27

Lower rates make Australia less attractive to foreign investors, leading to less demand for AUD (depreciation), which makes X cheaper and more competitive.

Question 28

What is the ‘wealth channel’ in MP?

Answer 28

Lower interest rates increase asset prices due to higher demand, making asset holders feel wealthier, which often leads to increased spending.

Question 29

What effect does contractionary MP have on the economy?

Answer 29

raises interest rates, reduces spending and investment, lower eco activity, (potentially) lower inflation, raise unemployment

Question 30

Why is the exchange rate channel important in the impact of interest rate changes?

Answer 30

Higher Aus rates can attract foreign investment, strengthening the AUD and making M cheaper (lower prod’n costs, lower consumer P, increased competition), which can help reduce inflation

Question 31

What is the ‘time lag’ in MP

Answer 31

It is the 12-24 month delay before the full effects of an interest rate change impact the economy

Question 32

Why does the RBA focus on future economic conditions when setting MP?

Answer 32

Because of the time lag, the RBA tries to predict the economy 12-24 months ahead to set policies that align with the future.

Question 33

What historical trends can be observed in Australia’s interest rates?

Answer 33

Interest rates in Australia have fluctuated over time, with periods of rapid increases and decreases in response to economic conditions.
E.g. in the early 1990s, the RBA rapidly cut interest rates to combat a recession, while in the mid-1990s, rates were quickly raised to combat rising inflation

Question 34

How did the RBA respond to the economic impact of COVID-19?

Answer 34

The RBA made MP very expansionary by lowering the cash rate to 0.10% and introducing unconventional measures to support the economy.

Question 35

What led to rising inflation in 2022 and 2023?

Answer 35

It was driven by global supply chain issues , the way in Ukraine, high inflation overseas, and strong AD.

Question 36

What is the RBA’s inflation target.

Answer 36

2-3%

Question 37

How do inflationary expectations influence MP?

Answer 37

Low inflationary expectations lead to lower price increases and wage demands, which the RBA aims to maintain through interest rates adjustments.

Question 38

What role do labour costs play in MP?

Answer 38

Labour costs and productivity trends are significant determinants of inflation (high wage growth=more spending), influencing future interest rate movements.

Question 39

What is the RBA’s commitment regarding unemployment?

Answer 39

RBA aims to achieve low unemployment while promoting economic prosperity.

Question 40

How do external factors influence Australian MP

Answer 40

Global eco conditions impact the RBA’s MP decisions, particularly in times of economic volatility.