Task description: In this task, you will build a case study based on the article: RBA decision 7th August 2018
The RBA board meets 11 times a year (not in January) at the RBA in Martin Place, Sydney. Prior to the meeting, board members are provided with analysis of the economy and the financial markets by the RBA staff (prepared by the Economic Analysis Department). Among these analyses are the bank’s forecasts of future inflation, as well as the likely future path of economic growth overseas and domestically. RBA monetary policy decisions are based on these analyses as well as a range of other macroeconomic assumptions. In addition, scenarios are provided as to the likely macroeconomic outcomes if monetary policy was adjusted. The RBA meeting occurs on the first Tuesday of each month. After much discussion, a consensus decision is reached as to whether to leave interest rate unchanged or to adjust these rates. The instrument that RBA uses is the cash rate and, if an adjustment is decided, it will be to adjust the cash rate by 0.25 per cent, 0.50 per cent or 1 per cent. The most common adjustments are
0.25 per cent and 0.50 per cent. Since the last decade, the adjustment has been at 0.25 percent. With the unfolding of GFC, the RBA monetary policy response has been to cut the cash rate six times since September 2008 and cuts have been as large as one per cent. These cuts were designed to help Australia avoid the synchronised international recession, which hit all of the major economies in the 2008-2010 period.
Once the decision is made, the RBA Governor announces its decision and, if a rate adjustment is made, banks will potentially make changes to their interest rates the following day. RBA also publishes the minutes of its Board meetings two weeks after each meeting and provides
quarterly statement on the Monetary Policy. The RBA does not set this interest rate (as the commercial bank sets its mortgage rate), but it continuously influences the rate through its daily financial operations in the money markets. If the RBA buys Treasury notes, the supply of excess reserves in the banking system increases and the cash rate falls. If the RBA sells Treasury notes, the supply of excess reserves in the banking system decreases and the cash rate increases. Because of these changes in the cash rate, interest rates in general are influenced. In May 2015, RBA cut the official interest rate to 2.0 percent, which remained unchanged for a year. In May 2016, RBA governor announced a cut in cash rate by 0.25 basis point, to 1.75 percent, which remained unchanged until August 2016. The official cash rate since August 2016 has been at the historical low of 1.50 percent for 2 hours.
Question 1: Why does the RBA takes into account the domestic (Australian) and global (China, Japan, and USA) macroeconomic indicators (GDP growth rate, investment, household consumption, inflation, unemployment, and exchange rate) when making a decision whether to change (increase or decrease) or keep the official cash rate unchanged? Explain.
Question 2: Explain the main objectives of monetary policy. List and describe the main functions of money and the Reserve Bank of Australia.
Question 3: On 7-August-2018, the Governor of the RBA, Dr Philip Lowe, decided to leave the official cash rate unchanged at 1.50 percent as house prices continue to fall. Why did the RBA keep the cash rate unchanged for the last 2 years? Justify your answer with reasons and evidence.
Question 4: Illustrate and explain using the money market equilibrium model and monetary transmission mechanism how an increase in the cash rate from 1.5% to 2% would help to keep inflation within the target rate, and how a further decrease from 1.5% to 1 % in the cash rate would help to stimulate the economy. In particular, discuss the effect on household consumption, business investment, GDP, inflation and housing market. Describe the circumstances in which the RBA Board might increase the cash rate.
Question 5: Define economic growth. What are the determinants of long-run economic growth? Is the historically low interest rate of 1.50 percent (from August 2016 until the August 2018) sustainable to achieve long-run economic growth? Yes/No, justify your answer with reasons. Note: Students need to give their own views supported and justified by several references and examples.
The RBA which stands for the Reserve Bank of Australia is the Australia’s central bank. It derives its powers and functions from Reserve Bank Act which was established in the year 1959 (Brown, & Karpavi?ius, 2017). The duties played by the central Bank of Australia consist of; ensuring that Australia’s currency remains stable, the level of employment in the country is high and ensuring that there is well being of the citizens and Australian economy prospers. The method used by the Australian central bank to ensure that these duties are achieved is by setting the cash rate, bank notes issuing, efficient system payments, and finally maintenance of strong systems in finance. The RBA also makes provision of banking services as required by the Government of Australia and its agencies, and also a number of central banks overseas. The Australian central bank in addition does gold and foreign exchange management. The location of the central bank of Australia head office is in Sydney with more branches overseas and also around Australia itself. The bank is supported by the Information management Policy in the creation, storage and the usage of information in digital environment thus equipping the bank with the Governments Transition Policy. The bank is responsible for controlling the cash rate because it sets the target interest rate for the overnight funds. The RBA uses cash rate as the as the instrument of monetary policy and as a result uses it to influence the cash rate through its financial market operations (Cusbert, & Kendall, 2018). The decisions on how to change the market rate are made by the Reserve Bank of Australia board members and the then afterwards a media report making announcement on the decisions that have been made at 2.30 pm.
Answer 1: Why does the RBA takes into account the domestic (Australian) and global (China, Japan, and USA) macroeconomic indicators (GDP growth rate, investment, household consumption, inflation, unemployment, and exchange rate) when making a decision whether to change (increase or decrease) or keep the official cash rate unchanged? Explain.
The Reserve Bank of Australia (RBA) looks into account and compares domestic and global macroeconomic indicators because comparing the two brings out the best future performance that reflect the position of the economy of Australia before agencies and the real economic action occurs (Lane, & Rosewall, 2015). The reason behind this is that the Reserve Bank of Australia has been given the task of ensuring that there is prosperity and well-being of the people of Australia. To achieve this goal, they use the monetary policy in attempting to control inflation, stabilize the Australian currency, maintain full employment in Australia, ensure well-being of people of Australia and finally promote economic prosperity. The decision to compare the domestic and the global economy depends on the amount of money circulating in the economy which makes the RBA decide on whether to lower, raise or maintain the cash rate (Chen, Zhang, Tam, & Wu, 2018). This is the point where the comparison is made between the strengths of the larger growing economies i.e. the global economies and the domestic economy. For the international economic conditions the Reserve Bank of Australia account for the strengths of the global economy in terms of housing markets, the demand of the consumer and the performance of the currencies. On the other side of domestic economic conditions, the performance of the economy in terms of employment and unemployment level is checked. High unemployment increases the chances of rate decreases because low rates boost business expenditure, investments and the overall job employment. The inflation level is also checked because when the inflation is high, it increases the chances of the consumer demand. In the process of fighting inflation in the country RBA raised the cash rate to keep the inflation low something they have done for many years to maintain inflation between 2 – 3%. RBA also checks the business and consumer confidence because when business or consumer confidence is low, then these two stimulate the likelihood of cash rate decrease because cash rate decrease stimulates demand hence business expansion. The level of household debt is also looked at. It is known historically that lower interest rates tend to boost the price of housing in capital city business areas. Other methods such as the restriction on requirement of lending may also be more effective in the control of housing market. The currency of the nation i.e. the nation of Australia also tries to influence the strength of the dollar through the official cash rate. Is the cash rate in our country is high, then the comparison to other western countries can make our dollar strong thus investors investing in our country put more money in our country. On the other hand, strong dollar might be god for the importers but also bad fot the exporters. The stability of the financial markets is also checked on their lending and their deposit accounts rates in particular. Finally the last review is in regard to their previous decision on the cash rate effects on the social banking. Additionally they will give the weighing on how consistence inflation is to their projections as well as the future outlook to their growth. Upon the discussion of the above macroeconomic indicators, a comparison is made mostly for the housing markets overseas, the demands of the consumers and the performance of the currencies of countries with higher growing economies such as China, The United States of America and also some of the larger European countries like Japan among others. Comparing the two help the RBA see the effects that might arise after raising, maintain or lowering the official cash rate. Thus comparing the two economies makes the Reserve Bank of Australia learns in advance the effects that might arise after deciding on whether to rise, maintain or lower the cash rate hence enabling them change the cash rate in the favor of the nation of Australia (Rey, 2015).
Answer 2: Explain the main objectives of monetary policy. List and describe the main functions of money and the Reserve Bank of Australia.
First monetary policy refers to the policy laid out by the central bank for the management of money supply, interest rates and used by the country’s government to achieve its macroeconomic objectives such as growth, liquidity, inflation and consumption. The objectives of monetary policy are: One, the maintenance of country’s currency stable (Llewellyn, 2016). When stabilizing the currency, the main goal is to always keep checking the inflation. When the money you have purchases little things today than the previous days, then this is what we call inflation. It can be defined as the decrease in the purchasing power of money. Secondly, it is the maintenance of full employment in the country. Full employment refers to a situation where there is no unemployment. But in real sense this cannot happen because we cannot come to a situation with zero unemployment. There might be some unemployment because people change jobs, other prefer to stay unemployed waiting for a well-paying job than accepting a job that is paying less. Therefore, when we say full employment we mean a situation where there are not more than 3% of the population that is working are unemployed. We also have economic prosperity and well-being of the people in a country which refers to the quality of the living standards in an economy. Various factors are used to measure the economic welfare such as GDP, literacy, level of pollution, and number of doctors. Money has various functions in the country’s economy (Pham, Liu, & Roca, 2015). For instance money is used as a medium of exchange to facilitate transactions. If money was absent, then all transactions would be done through barter which involves exchanging goods and services for other goods and services. Money is also used as a store of value. For money to be used as a medium of exchange, it must possess a value equivalent to the product that it is being exchanged for. It is because of this reason that money is said to be used as a store of value. Money is also used as a unit of account. When used s a unit of account, it provides a common measure of goods and services being exchanged. The knowledge of the price or value of a good in terms of money, it makes the purchaser and the seller of the good to decide on the quantity of goods to supply and also the quantity of goods to purchase. The Reserve Bank of Australia plays an important role in Australia. For instance, the RBA works to promote the overall financial system stability. It seeks to mitigate risks of financial disturbances that may have systemic consequences, and replying to any financial disturbance in case it occurs. RBA also produces and issues Australia’s bank notes with the objective of ensuring confidence in bank notes as a mechanism of effective payment and wealth storage that is secure. The bank offers special banking services to government and official institutions that are foreign (Bekaert, Ehrmann, Fratzscher, & Mehl, 2014). The services are composed of payments and collections together with reporting and general account maintenance. The RBA manages the Australia’s foreign currency reserves; it operated foreign exchange market on a regularly in order to achieve foreign exchange desires of the clients and also to assist in domestic liquidity management.
Answer 3: On 7-August-2018, the Governor of the RBA, Dr. Philip Lowe, decided to leave the official cash rate unchanged at 1.50 percent as house prices continue to fall. Why did the RBA keep the cash rate unchanged for the last two years? Justify your answer with reasons and evidence. (Note: information found in detail monthly minutes of RBA)
There were various reasons that made the Governor of RBA Dr. Philip Lowe decide to let the cash rate remain at 1.50 percent. Firstly, there was existence of the vulnerable over indebted economic shocks and households. The concerns of RBA were on how interest rates change would have impact on the households’ disposable incomes. Secondly, the continued decrease of prices of homes across the country of Australia for the previous three months had caught the central bank’s attention and the believe that was there was that any increase in cash rate would put more pressure on the housing market across the whole nation. Mitchell on the other hand pointed out that for the first quarter of June, Consumer Price Index didn’t meet the market expectation and it was below the target range set by RBA, raising 0.4% on the previous quarter and 2.1% annually. The economists made identification on the consumer and business sentiment data, and the conditions of the business across industries as some among other reasons behind RBA’s decision. Last but not least, the rate of unemployment nationally also contributed to the key factors considered by RBA in making their final decision of maintaining the cash rate at 1.50 percent (Broten, & Collins, 2017). This is because according to the latest Labour Force Survey from the Australian Bureau of Statistics the unemployment rate is now 5.4%. This same point was shared by Tim Lawless who said that the steady rate was had something to do with the slack labour market. He also added that the low inflation, the high household inflation and the falling value of dwelling were among the key drivers of the rate remaining unchanged. Lawless also added that the cash rate may remain unchanged until the year 2020. Mitchell supported the maintenance of the cash rate saying that raising or reducing the cash rate would have negative impact on the economic growth and as a result cause undue pressure on family finances. She also added that putting aside the complexity of the environment of borrowing, there was no benefit for the prospective buyers on the soft property prices and also in the lowest mortgage rate in decades.
Answer 4: Illustrate and explain using the money market equilibrium model and monetary transmission mechanism how an increase in the cash rate from 1.5% to 2% would help to keep inflation within the target rate, and how a further decrease from 1.5% to 1 % in the cash rate would help to stimulate the economy. In particular, discuss the effect on household consumption, business investment, GDP, inflation and housing market. Describe the circumstances in which the RBA Board might increase the cash rate.
When the cash rate increases from 1.50 to 1.00 percent, increased interest rates is thought to have effects on the consumer consumption by both substitution and also income effects (Rey, 2015). When the interest rates are high, the level of consumer consumption lowers through the effect of substitution. This is because the current level of spending became high and therefore consumer household’s consumption became reduce as well. On the other hand, high interest rates tend to increase consumption through the income effects because households (on net) receive more interest income. Increased cash rates affect business investments in that when the interest rates have been raised high, the cost of borrowing becomes high and therefore businesses fail to get loans from the financial institutions. The rate of investments is discouraged and thus inflation on products decreases. On the other hand, when the rates are decreased from 1.50 to 1.0, you find that businesses can access loans easily and this gives them more money to spend which results into inflation on products because there is a lot of money to spend. Businesses get money for spending in purchasing of equipments due to the low cost of borrowing. Looking at the effects of increased interest rates on GDP, you find that there are various effects that are connected with this. This is because the output of GDP is affected by consumption, investments, government expenditure and exports. Increased interest rate reduces consumption rate and therefore spending becomes high decreasing GDP. When the interest rates decrease, consumption rate increases and domestic expenditure becomes cheaper thus increasing the GDP. Looking at the effects of increased cash rate on inflation, you find that mostly the rates rise because they want to put brakes on inflation. Therefore whenever the cash rates increase, the level of spending lowers and the demand for products goes down (Lane, & Rosewall, 2015). This causes the sellers to lower their product prices and what we get is decreased inflation. Same way when cash rates decrease from 1.50 to 1.00 percent, what we expect is increased borrowing and this makes people have money to spend. With increased expenditure, demand rises and same way product prices rise resulting into inflation. Finally checking the effects of housing markets because of increased interest rates, we find that actually increased interest rates don’t decrease demand for housing, what they do is just moving it around. That is they shift housing demand from areas where new households purchase homes to the areas where new homebuyers rent from investors. This doesn’t lead to reduces cards number in the housing finance deck. What this is just cards shuffling leaving investors holding trumps.
Answer 5: Define economic growth. What are the determinants of long-run economic growth? Is the historically low-interest rate of 1.50 percent (from August 2016 until the August 2018) sustainable to achieve long-run economic growth? Yes/No, justify your answer with reasons. Note: Students need to give their views supported and justified by several references and examples.
Economic growth refers to the increased production of goods and services over a period of time that an economy produces. The measurement of economic growth is calculated as the change in the percentage rate in the real gross domestic product (GDP). On the other hand, what basically long-run economic growth means is that, it’s the sustained quantity of goods and services raise that is produced by an economy (Naifar, 2016).
GDP measuring: the percentage increase in GDP is economic growth. GDP on the other hand impacts the Long-run growth.
We have various determinants that impact the long-run economic growth. First, we have the economic productivity which is the outputs to inputs economic ratios i.e. energy, labor, capital, services and material. Increased rate of productivity results to reduced cost of goods. Reduced product priced leads to increase demand of the product or service by the consumers and thus increased demand results into higher revenues (Atkin, & La Cava, 2017). Secondly, we have demographic changes which influence economic growth by the employment ratio change. Some of the factors consist of quantity and the quality of the natural resources availability. The long-run growth is also influenced by the structure of the age of the population. Thirdly, we have Labor force participation. Here the economic sectors size and the participation of the labor force influence labor force. What actually labour force means is the amount or number of workers available. Most of countries that are undergoing extensive development and industrialization, the level of participation of labor force is high because of low birth rate and death rate (Galí, 2015).
Is the historically low-interest rate of 1.50 percent (from August 2016 until the August 2018) sustainable to achieve long-run economic growth?
When the central bank of Australia left the cash rate at 1.5 percent, it noted a slow growth in the wage and also the inflation despite economic discovery from the its weakness. Historically, a 20,000 jobs growth in employment is expected to continue in driving the Gross Domestic Product GDP data to 2.9 percent in the year to March and also a 12 percent increase in LNG shipments and 4 percent coal boost. Due to this reasons, the board remained in hope that the economy would grow above 3 percent in the year 2018 to 2019 thus beating the May budget expectations.
There are various advantages of maintaining low cash rates on the economic growth. For instance, low cash rate would lead to slow economic growth and thus there would be deflation on goods and products, deflation would be witnessed on house prices, there would be increased employment and therefore the unemployment rate would be low (Alessi, & Detken, 2018). This will make the economy of a country grow slow but for a longer time.
In conclusion the decision made by the Reserved Bank of Australia of maintaining the cash rate at 1.50 percent has come when the financial markets were much expecting it. The low level interest rate offered by the financial institutions of Australia are continuing to support the Australian economy as said by the by the Reserved Bank of Australia committee. This is because according to the judgment given by the bank, that taking the account of the availability of the information, and the maintaining of the monetary policy in that meeting would be consistent with the economic growth that is sustainable and also achieving the goal of inflation target over the time. The further expected results of maintaining the cash rate constant is continued reduction in the unemployment rate and also have the inflation rate return to what the Reserve Bank of Australia expected. This will be achieved though; the process is expected to be gradual. The comments from the bank are that the likelihood of maintaining the cash rate low are high because It allows low growth in labor costs and creates strong competition in the retailing market.
Alessi, L., & Detken, C. (2018). Identifying excessive credit growth and leverage. Journal of Financial Stability, 35, 215-225.
Atkin, T., & La Cava, G. (2017). The Transmission of Monetary Policy: How Does It Work?. RBA Bulletin, 01-08.
Bekaert, G., Ehrmann, M., Fratzscher, M., & Mehl, A. (2014). The global crisis and equity market contagion. The Journal of Finance, 69(6), 2597-2649.
Broten, N., & Collins, J. (2017). The Role of Monetary Policy. Macat Library.
Brown, A., & Karpavi?ius, S. (2017). The Reaction of the Australian Stock Market to Monetary Policy Announcements from the Reserve Bank of Australia. Economic Record, 93(300), 20-41.
Chen, Y., Zhang, H., Tam, K. L., & Wu, M. (2018). The Making of Contemporary Australian Monetary Policy-Backward-or Forward-Looking?. International Journal of Economics and Finance, 10(6), 127.
Cusbert, T., & Kendall, E. (2018). Meet MARTIN, the RBA's New Macroeconomic Model. Australian Reserve Bank Bulletin, March, 31-44.
Galí, J. (2015). Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework and its applications. Princeton University Press.
Lane, K., & Rosewall, T. (2015). Firms’ investment decisions and interest rates. Reserve Bank of Australia Bulletin. June quarter, 1-7.
Llewellyn, N. (2016). ‘Money Talks’: Communicative and Symbolic Functions of Cash Money. Sociology, 50(4), 796-812.
Naifar, N. (2016). Do global risk factors and macroeconomic conditions affect global Islamic index dynamics? A quantile regression approach. The Quarterly Review of Economics and Finance, 61, 29-39.
Pham, Q. C., Liu, B., & Roca, E. (2015). The Mortgage Interest Rates and Cash Rate Cycle Relationship and International Funding Cost: Evidence in the Context of Australia (No. finance: 201504). Griffith University, Department of Accounting, Finance and Economics.
Rey, H. (2015). Dilemma not trilemma: the global financial cycle and monetary policy independence (No. w21162). National Bureau of Economic Research.
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