Econ Class 14

Monetary Policy:

• Monetary policy is an anticipatory, discretionary, counter-cyclical demand-side policy administered by the Reserve Bank of Australia through changes in the cash rate to achieve price stability
  • Anticipatory: Creating future plans and executing relevant actions
  • Discretionary: Based on the judgement of policymakers. In Australia's case this is the Reserve Bank of Australia, which is independent from the government.
  • Counter-cyclical: Go against the current direction of the BTC
  • Demand side: This impacts aggregate demand in a macroeconomy.
• This is done to solve the main issue in economics, inflation.
• Every country suffers from inflation, as there exists supply chain issues which cause inflationary pressures.
• But difference countries deal with it differently.
• e.g. Turkey didn't raise interest rates, therefore their economy is bad (not really, but it is now :( )
• In comparison, Australia has recently increased interest rates, to reduce demand and decrease inflationary pressures.
• The main tool of monetary policy is the cash rate, the interest rate of the Reserve Bank of Australia, OR the rate they charge banks in the overnight money market.
• The PRIMARY PURPOSE of the RBA is price stability, by keeping inflation in check.
  • The overall aim of Monetary Policy is to contribute to the macroeconomic stability of the economy. Whilst the primary focus is price stability, Monetary Policy is also concerned with economic growth and employment.
• In others words, "to meet the inflationary target of 2-3%."

Objectives of Monetary Policy

• Stability of the currency
  • The objective is interpreted to mean low and stable inflation
  • Inflation: The general rise of level of prices of the goods and services that households buy.
  • Low and stable inflation preserves the value, or purchasing power, of money over time.
  • Australia has a flexible medium-term inflation target, which is to keep consumer price inflation between 2-3%, on average, over time.
• Full employment
  • This objective relates to the Reserve Bank promoting an environment that supports full employment.
  • Full employment: where there are enough jobs for people who are available and want to work.
    • Even at full employment, some people might be unemployed because of skill mismatches or as they move jobs. It is essentially impossible to have everyone employed, so RBA works towards the unemployment target of 4-5%.
• Economic prosperity and welfare
  • This objective relates to the Reserve Bank promoting an environment that supports the economic prosperity and welfare of the Australian people.
  • This is primarily achieved by maintaining a stable macroeconomic environment

Transparency:

• The RBA's decisions about monetary policy are expressed publicly, to ensure accountability.
  • It gives the business community confidence, and allows them to make informed decisions on their business actions.
  • It gives consumers confidence, as consumers can plan for things, e.g. cash rate changes.

Types of Monetary Policy

• Expansionary
  • Trying to expand the economy. Here, we are lowering interest rates.
• Contractionary
  • Trying to contract the economy. Here we increasing interest rates. ==We are doing this right now!!==
  • e.g. Q: What is the current stance on monetary policy: A: Contractionary.
    • What is contractionary policy: Trying to increase the cash rate to induce a contractionary phase in the BTC.
    • What is the current cash rate? Look this up before the test.
      • Say this is aggressive.
• Neutral
  • They do nothing, but sometimes it can still be contractionary/expansionary. However, if GDP growth stays at one point for a long time, it is considered neutral.

Transmission of Monetary Policy!!

• The transmission mechanism is the process undertaken to increase the cash rate. It occurs in step!
• 1st Step: Must raise or lower the cash rate. The RBA will raise or lower the cash rate.
  • NOTE: One of the weaknesses of monetary policy is that other banks don't have to listen to RBA.
    • It has some ways to make other banks to follow, but it can't directly order them.
• 2nd Step: Other interest rates change as a result, but are not forced to. Complex steps:

1. RBA changes cash rate. Usually by half a percent. Sometimes by a full percent. For example, if we want contractionary policy, we will increase the cash rate.

2. Transmission Channel No 1: Consumers must borrow money, to buy big-ticket items. When cash rates increases, people are less incentivised to buy things, e.g. houses. This reduces demand for item, meaning their prices fall. Thus, Channel No 1 is the consumption channel, and its really important as this influences consumers. If demand for a product increases too much, increasing the cash rate decreases the demand for this product. Furthermore, for houses, decreasing demand results in reduced labour. Thus, the consumption channel can have a big impact. Same thing applies with cars, e.g. people who make cars lose business.

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