u4aos1 - monetary policy Flashcards
define
Transmission mechanism
The transmission mechanism (or transmission channels) refers to the way a change in RBA’s cash rate will ultimately affect economic activity (aggerate demand) and inflation.
- COC
- CF
- AP
- EXC
Cost of credit (savings + investment channel)
def + domino
- RBA ↑CR signal a tightening in labour monetary policy
- ↑CR => ↑IR
The cost of credit channel is the transmission mechanism through which changes in IR effects the COC and therefore the wider economy
- ↑IR = more costly to borrow
* more expensive to take out a loan (future loans) -> more expensive to take out a loan
*more return on savings - ↓willingness to borrow = ↑incentive to save
- ↓C +
- ↓I (delay investment spending)
- ↓AD
Cash flow Channel
def + domino
- RBA ↑CR signal a tightening in labour monetary policy
- ↑CR => ↑IR
The cash flow channel is the mechanism through which the cash rate and interest rate change affect the level of repayments on loans for those with existing variable rate loans (such as mortgages, personal loans, credit cards and business investment loans)
- ↑IR (tighten monetary policy)
- ↑repayments on existing variable loans
- ↑ debt repayments (+↓ cash flow)
- ↓discretionary income (more money need to pay back mortgage)
- ↓C
- ↓AD
Assets and price channel
def + domino
- RBA ↑CR signal a tightening in labour monetary policy
- ↑CR => ↑IR
The asset price channel is the transmission channel that is responsible for the effects induced by monetary policy decisions that affect the price of assets
- ↑IR (tighten monetary policy)
- ↓demand for major assets (e.g., house)
- Consumer experience negative wealth effect
- dec pecervided self wealth
- feel poor and less able to spend
- ↓C
↓AD
Exchange rate Channel
def + domino
- RBA ↑CR signal a tightening in labour monetary policy
- ↑CR => ↑IR
The exchange rate channel is the mechanism through which changes in monetary policy (the cash rate) in Australia impact the value of the Australian dollar.
- ↑IR (relative to OS)
- (attract overseas investment opportunities)
- ↑capital inflow (↑payments in AUD = ↑money in AUST)
- ↑demand for AUD on the foreign exchange market
- ↑AUD (appreciate)
- AUST g/s appear RELATIVELY more expensive relative to TP
- TP incentives to trade with other TP
- loss of international competitiveness
- ↑M and ↓X
↓AD
Strengths of MP
-
implemented independently
- free of political bias (/influence)
- e.g., May 2022 election, RBA ↑CR
-
Short implementation Lag
- monthly adjustments possible
- Takes little time to implement an MP decision once RBA decides to change policy settings
- CR auto adjusts to higher CR announcement
=============== not as important===============
3. Good Restraining AD
* immediately deduces discretionary income of indebt households
4. Flexibility
can just unconventional methods (quotative lending) to support more conventional measures (changes to CR)
Weakness of MP
-
Impact Lag
- can take up to 2 years to fully impact the economy
- decision making forward looking based on forecasts (anticipatory policy)
-
Not effective against cost inflation
- cannot directly reduce inflationary pressures that are generated by supply side of economy (e.g., wages, energy prices)
-
Blunt instrument
- Effects all sectors of the economy
- cannot discriminate -> cannot target specific sectors/needs of groups)
- e.g., families with debt/mortgages
=============== not as important===============
- No direct control over IR
- extent to which CR changes flow through to changes to all other IR depends on competitive pressure of financial markets
- Less effective in stimulating AD during a downturn
- low confidence
- higher level of private sector indebtedness
- Exchange rate channel
- IR differentials
other countries changes to IR
- IR differentials
Stance of monetary policy
Neutral
DEF + GOALS + CR goal + what is the aim?
CR at 3-3.5%
Meeting the goals
The cash rate that prevails when internal stability is achieved and the cash rate is neither stimulating or contracting the economy
- aiming to: keep AD the same
Stance of monetary policy
Expansionary (losening/accommodative)
DEF + GOALS + CR goal + what is the aim?
CR <3%
slow rate of EG
high rate UNN
low inflation
Cash rate is low enough to stimulate AD and increase inflationary pressure
- aiming to: ↑AD
Stance of monetary policy
Contractionary (tightening/restrictive)
DEF + GOALS + CR goal + what is the aim?
CR >3%
high rate of EG
low rate of UNN
high inflation
the target cash rate is high enough to restrain AD and reduce inflationary pressures
- aiming to: ↓AD
Conventional monetary policy
When CR != TCR what can the RBA do to inc CR??
domino + what is it called?
“OPEN MARKET OPERATION” takes place
* This is the process involved in the manipulation of liquidity in the cash market by the RBA via purchasing and selling of government securities
So:
* The RBA can sell government bonds (which are literally pieces of paper of IR)
* to BANKS, which can
* decrease supply of money in OMM
* inc CR
- Conventional way RBA implements monetary policy is primary through via changing the cash rate which enables the RBA to indirectly affect all other interest rates
Conventional monetary policy
When CR != TCR what can the RBA do to DECREASE CR??
domino + what is it called?
“OPEN MARKET OPERATION” takes place
* This is the process involved in the manipulation of liquidity in the cash market by the RBA via purchasing and selling of government securities
So:
* The RBA can BUY government bonds (which are literally pieces of paper of IR)
* to BANKS, which can
* INCREASE supply of money in OMM
* dec CR
- Conventional way RBA implements monetary policy is primary through via changing the cash rate which enables the RBA to indirectly affect all other interest rates
Conventional monetary policy
What is Interest rate corridor
The ceiling (TCR+0.25)
* rate at which RBA charges/lends money to banks
* thus get money from OMM
The floor
* rate at which extra funds in the ESA gets interest upon
* So disincentive to keep money in ESA
Thus, banks are incentived to balance ESA THROUGH omm
* so CR is rate at which they borrow money from OMM
* this is passed on to us as IR
*
by law: ESA need to be balanced
- Conventional way RBA implements monetary policy is primary through via changing the cash rate which enables the RBA to indirectly affect all other interest rates
Define MP
a policy operated by the RBA on behalf of the government and involves the manipulation of key financial variables in the economy (primiarily ir) in order to achive specific economic goals and ultimately improve the living standards or welfare for all Australians
Unconventional MP example
foward guidence
* provide markets with a degree of certainity about the future direction of IR
* e.g., RBA predicted that the CR wiull not rise until 2024, which is designed to give businesses/consumers more confidence to borrow and invest/spend
Term funding facility
* RBA can introduce a term funding facility so banks can borrow from RBA at a discounted rate
* Offers support for small and mid size businesses
support to inc AD
