Yr 11: Monetary Policy, Inflation & the AUD (Concepts)

Question 1

What was the cash rate prior to the pandemic in 2019?

Answer 1

0.75%

Question 2

What did the RBA change the cash rate to during the pandemic?

Answer 2

0.1%

Question 3

What did the RBA change the cash rate to in 2023?

Answer 3

4.1%

Question 4

How did the RBA conduct unconventional monetary policy during the pandemic?

Answer 4

They reduced the bond yield on Government bonds by conducting:

1) Forward guidance
2) Asset purchases

Question 5

Why is the bond yield curve upward sloping?

Answer 5

If lenders expect interest rates to rise in the future, they will charge higher interest rates on longer-term loans to make up for the opportunity cost of lending at a higher interest rate in the future

Question 6

Why did forward guidance reduce the interest rate on government bonds?

Answer 6

By creating expectations that interest rates won’t increase over the next 3 years, lenders didn’t charge a higher interest rate on loans over that period

Question 7

Why did asset purchases reduce the interest rate on government bonds?

Answer 7

By printing money and buying government bonds, the RBA increased the price of government bonds which squeezed down the yield earned as interest on those bonds

Question 8

Why did reducing the bond yield on government bonds reduce interest rates throughout the economy?

Answer 8

The interest rate on lending to the Australian Government is considered a risk-free rate, so all other interest rates are equivalent to the government bond rate plus an extra risk premium

Question 9

How much money did the RBA print to spend on asset purchases during the pandemic?

Answer 9

$281 billion

Question 10

What was inflation in Australia prior to the pandemic?

Answer 10

It had been between 1.5-2% since 2015

Question 11

What happened to inflation during the pandemic?

Answer 11

It fell to -0.3%

Question 12

What has happened to inflation in 2023?

Answer 12

It has spiked to 7.8%

Question 13

Why did inflation fall in the pandemic?

Answer 13

1) Consumption and aggregate demand fell due to lockdowns
2) The government fully subsidised child care temporarily, making the price of childcare fall from around $100 per day to $0

Question 14

Why did inflation spike so much in 2022 and 2023?

Answer 14

1) Global supply chain disruptions
2) Russian sanctions
3) Floods
4) The recovery in consumption following the end of restrictions and lockdowns
5) Expansionary macroeconomic policies
6) Unemployment is low, so wages are starting to rise and increase inflation even more

Question 15

What are supply chain disruptions and why have they affected inflation?

Answer 15

Due to covid, there have been disruptions to the production of inputs (such as computer chips) and the transportation of goods between countries, which have increased business costs

Question 16

What are Russia sanctions and why have they affected inflation?

Answer 16

Due to Russia’s invasion of Ukraine, most countries have stopped buying Russian exports. This has reduced the supply of commodities such as oil, increasing input costs

Question 17

Why have floods affected inflation?

Answer 17

By destroying farm production, supply of food products fell causing prices to rise

Question 18

Why is low unemployment likely to increase inflation even more?

Answer 18

When unemployment is low, workers are able to negotiate higher wages (because firms are competing with each other to attract the scarce labour), pushing up firms’ costs

Question 19

How well has the government managed inflation?

Answer 19

The recent spike in inflation is mostly due to cost inflation that the government can’t control. However, it has been made worse because fiscal and monetary policy was so loose in the pandemic and was not tightened quickly enough.

Question 20

In which year did the mining boom start?

Answer 20

2003

Question 21

In which year did the AUD peak in value during the mining boom?

Answer 21

2011

Question 22

What was the % change in the value of AUD between 2003 and 2011?

Answer 22

55% increase

Question 23

What was the % change in the value of the AUD between 2011 and 2022?

Answer 23

35% decrease

Question 24

Why did the AUD rise between 2003-2011?

Answer 24

There was an increase in demand for the AUD because of rising foreign investment into Australian mining firms. Firms needed this investment to expand mines and build new transport infrastructure, in response to high global demand and prices of commodities

Question 25

Why did the AUD fall between 2011-2015?

Answer 25

There was a decrease in demand for the AUD because the level of financial investment into mining firms had finished expanding the mines and building new infrastructure

Question 26

How well has the RBA used monetary policy to stabilise the business cycle?

Answer 26

The RBA used record-low interest rates and unconventional monetary policy to dramatically support growth, employment and inflation in the pandemic.

However, the RBA was too slow in reversing its expansionary monetary policy. This has contributed to the recent spike in inflation (although other factors have also contributed to the spike as well)