Yr 11: Monetary Policy, Inflation & the AUD Flashcards
What is monetary policy?
Changes to the interest rates in an economy to stabilise the business cycle
What is the RBA’s objective of monetary policy?
To stabilise inflation between 2-3% in order to achieve sustainable economic growth and low unemployment
What is the cash rate?
The interest rate on overnight loans between banks’ exchange settlement accounts
What is an exchange settlement account?
Banks’ accounts held at the RBA to settle transactions between their customers that occurred that day
What are 2 ways the RBA influence the cash rate?
1) Open Market Operations
2) Cash rate corridor
How does the RBA conduct Open Market Operations?
To increase the cash rate, the RBA would sell second-hand Commonwealth Government Securities to banks to reduce the supply of funds in their ESAs
If inflation was 4%, would the RBA buy or sell Commonwealth Government Securities?
Sell
If inflation was 1%, would the RBA buy or sell Commonwealth Government Securities?
Buy
The RBA wants to raise the cash rate. To do this, will they buy or sell Commonwealth Government Securities?
Sell
The RBA wants to lower the cash rate. To do this, will they buy or sell Commonwealth Government Securities?
Buy
Why does a change in the cash rate lead to a change in other interest rates in the economy?
The cash rate is a risk-free interest rate, so the interest rate on all other loans are made up of the cash rate plus a margin for the risk of that loan
Why does a change in interest rates lead to a change in inflation?
A change in interest rates flows through the transmission channel to shift aggregate demand and demand inflation
What are the 4 channels of the transmission mechanism?
1) Saving and borrowing
2) Mortgage repayments
3) Wealth effect
4) Exchange rate effect
What is the saving and investment channel of the transmission mechanism?
If interest rates rise, individuals will save more and consume less. Firms will also borrow less and invest less.
What is the wealth effect channel of the transmission mechanism?
If interest rates rise, individuals are less willing to borrow to buy assets such as houses. As a result, asset prices fall. The owners of these assets now feel less wealthy, so are less willing to spend on consumption
What is the mortgage repayment channel of the transmission mechanism?
If interest rates rise, the amount people spend paying interest on their mortgage rises. This leaves them with less money to spend on consumption
What is the exchange rate channel of the transmission mechanism?
If interest rates rise, foreigners will be more willing to lend to Australians. This increases the demand for the AUD, causing the AUD to appreciate. As a result, imports increase and exports decrease
Why would an increase in interest rates cause the AUD to appreciate?
If interest rates rise, foreigners will be more willing to lend to Australians. This increases the demand for the AUD, causing the AUD to appreciate.
The RBA raises the cash rate. Would inflation rise or fall?
Fall
The RBA lowers the cash rate. Would inflation rise or fall?
Rise
The RBA raises the cash rate. Would economic growth rise or fall?
Fall
The RBA lowers the cash rate. Would economic growth rise or fall?
Rise
The RBA raises the cash rate. Would the AUD rise or fall?
Rise
The RBA lowers the cash rate. Would the AUD rise or fall?
Fall
The RBA buys CGSs. Would inflation rise or fall?
Rise
The RBA sells CGSs. Would inflation rise or fall?
Fall
The RBA buys CGSs. Would economic growth rise or fall?
Rise
The RBA sells CGSs. Would economic growth rise or fall?
Fall
The RBA buys CGSs. Would the AUD rise or fall?
Fall
The RBA sells CGSs. Would the AUD rise or fall?
Rise
What are 3 causes of inflation?
1) Demand
2) Cost
3) Government policies
What is demand inflation?
Increased aggregate demand bids up the price of scarce products
What is cost inflation?
Higher costs of production mean firms have to charge higher prices for their products
How can government policies cause inflation?
1) If the government places taxes or removes subsidies on products, then the price of those products will change
2) If the government prints money, then there will be more money chasing the finite resources in the economy, bidding up the price of those products
What type of inflation would occur in an upturn in the business cycle?
Demand
What type of inflation would occur due to a rise in oil prices?
Cost
What type of inflation would occur due to an increase in the GST?
Government policies
What type of inflation would occur due to a fall in the cash rate?
Demand
What type of inflation would occur due to a decrease in income tax?
Demand
In Year 1, $1 = €3. In Year 2, $1 = €2. The AUD has…
Depreciated
In Year 1, $1 = €3. In Year 2, $1 = €4. The AUD has…
Appreciated
In Year 1, $3 = €1. In Year 2, $2 = €1. The AUD has…
Appreciated
In Year 1, $3 = €1. In Year 2, $4 = €1. The AUD has…
Depreciated
In Year 1, $1 = €3. In Year 2, $0.50 = €1. The AUD has…
Depreciated
In Year 1, $1 = €3. In Year 2, $0.25 = €1. The AUD has…
Appreciated
What are 2 reasons demand for the AUD could increase?
- Increased exports
- Increased foreign investment into Australia
What are 2 reasons supply of the AUD could increase?
- Increased imports
- Increased foreign investment out of Australia
What are 2 impacts of an appreciation of the AUD?
1) Imports become cheaper
2) Exports become less competitive (so foreigners buy fewer of them)
What are 2 impacts of a depreciation of the AUD?
1) Imports become more expensive
2) Exports become more competitive (so foreigners buy more of them)
