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The impact, mechanics and the effectiveness of the RBA’s monetary policy decision

Questions to be addressed in your essay:

1: Describe monetary policy and its intended objectives. Discuss the functions of the Reserve Bank of Australia (RBA).

2: At the March meeting, the RBA Board decided to leave the cash rate unchanged at 1.5%. In the past, the Board had changed the cash rate. Using money market equilibrium model and the transmission mechanism, illustrate and explain how a change in cash rate might help to control inflation or stimulate the economy. Describe the circumstances in which the Board might increase and decrease the cash rate.

3: Discuss the main factors, including the current inflation rate that influenced the RBA Board’s March decision to leave the cash rate unchanged. Comment on the trends in key macroeconomic indicators mentioned in this media release. Using diagrams/graphs, support the arguments put forward by the RBA monetary policy decision.

 4: The RBA Board considered the conditions of the housing market when deciding on the cash rate. Discuss the impacts of changing the cash rate on housing market participants. Why should the RBA be concerned about the rapid property price growth and investor borrowing? Comment on the supervisory measures (also known as macro-prudential measures) mentioned in the RBA media release?

5: Discuss the limitations to conventional monetary policy and its implementation. Explain why some economists believe that monetary rules are a better policy option than discretionary inflation targeting.

Monetary Policy and Objectives

This report outlines on monetary policy adopted by Reserve Bank of Australia (RBA). The board of RBA uses this monetary policy in deciding cash rate and to make stable growth of the economy. In this regard, this report focuses on money market equilibrium model and transmission mechanism, which may be useful in controlling inflation. Furthermore, this report describes different factors that may be used by the RBA’s board member to decide the cash rate effectively.

Monetary policy of the country describes the practices by which the central bank or financial regulatory authorities of a country manages the supply position of country’s currency. Monetary policy in general influences inflation rate and interest rate to ensure price stability that creates general public trust in the currency. The monetary policy of the country functions as a tool to stabilize and maintain equitable balance in the economic structure of the country.  The main objectives of the monetary policy are -

Neutralization of Currency market activities- The key aim of the monetary policy is to safeguard the economic environment against deviating money market activities and neutralize the effect of such variations to control supply and demand position of currency.

Exchange Stability: The objective of monetary policy is to uphold constancy in the external balance of payments of the country and reduce those adverse effects, which inclines to fluctuating exchange rates.

Price Stability: Price stabilization as objective of monetary policy encourages business actions and assures fair distribution of income among the national residents.

Full Employment: The other objective of monetary policy is to increase employment opportunity in the country and to eradicate unemployment statue among the youth’s society.

Economic Growth: Monetary policy of the country supports in sustaining and continuously developing economic factors through placing balance between demand and supply of money.

Functions of RBA:

The main responsibility of Reserve Bank of Australia's (RBA) is formulating monetary policy and its implementation and management to control the fiscal position of the country’s economy. Additionally RBA is responsible to develop stabilized financial structure and to ensure security and effectiveness of the payments arrangement of the country. RBA plays a vital role of active financial markets participant and manage country’s foreign reserves and serves as main banker of Australian government through issuance of currency notes.

Money Market Equilibrium Model

The fluctuations in the money market occurs when market participants raise or reduce the money market instruments they possess by trading into fixed interest rated short-term bonds like  corporate bonds,  debentures and treasury bills issued by the government. Money market reaches to state of equilibrium when demand and supply of money is equal at a particular rate of interest.

Functions of RBA

The figure also explains that quantity of money demanded is equal to prevailing money supply position at the interest rate of 10%. Therefore, equilibrium in the money market is observed at 10% rate of interest and this position derives the stabilized inflationary rate in present economic condition.

Transmission Mechanism

Effect of monetary policy on general households and business environment of the country forms the basis of transmission mechanism. Monetary policy essentially influences the demand of money in the economy and inflation rate. Aggressive alteration in the cash rate presents dynamic influences over the economy.

By the analysis of Money Market Equilibrium Model and Transmission Mechanism, it can be stated that the reserve bank of the country directs the rate of inflation in the economy through increasing the cash rate. This tends into increase the lending rate and increasing interest rates lower down the inflation rate.

Furthermore, if the government of the country is interested in promoting the infrastructural development of the country, which actually influences the employment status of the economy, the RBA will decrease cash rate. On the contrary, to manage the financial activities of the banking sector of the country and to provide liquidity to banks and financial institutions RBA will increase the cash rate.

The Reserve Bank of Australia (RBA) is responsible to ensure economic welfare and wealth of Australian people. In this regard, the board of RBA mainly focuses on monetary policy decisions that are based on cash rate. The below graph is sowing cash rate of Australia in present time:

From the study of previous data it is observed that the cash rate remains unchanged due to different domestic and international factors. In the global market, inflation rate is moved higher, which had been reflected to the higher commodity prices. But the higher commodity prices in international market supported to Australia’s national income because export of Australia risen strongly due to investment boom in mining sector. The increased export supported to the Australian economy in the world market. Therefore, the board of RBA decided to leave cash rate unchanged at 1.50 per cent.

Furthermore, there are different domestic factors that have affected the decision of board members of RBA. These factors are discussed as below:

Employment and unemployment figures: In Australia, the unemployment rate is stable over the past year but the employment of part-time jobs increased. Due to stable unemployment rate the cash rate remained stable because the variation in employment rate impacts on cash rate.

Money Market Equilibrium Model

Inflation rate: If, the inflation rate increases than the chance of increasing cash rate increases. It is observed that the inflation rate of Australia remained low in this year due to growth in labour cost.

Consumer confidence: The economy of Australia expanded it mining business by around 2½% in 2016 as well as non mining businesses. It have supported to consumer confidence and increased the consumption growth.

 Strong housing debts: In Australia, the borrowers for houses have picked up over the recent year, which had contributed in strengthening the country’s lending standards. Therefore, the board decided to remain unchanged the cash rate. Because the increasing the increasing debts supports to financial position of lenders.

Strong currency: RBA makes efforts to strengthen its currency through changes in cash rate. In the recent years, it is observed that many of the countries are facing inflation but the Australia has not influenced in this situation due to its increasing investment in mining and export. Investment in mining and increasing in export have supported to the nation’s economy. So, RBA did not change the cash rate.

Stability of Financiers: From 2013, the low interest rate supported to banks and financial institutions. In this regard, the RBA decided to leave the cash rate unchanged in March 2017 because there is no need to improve the cash rate in any concern of banks and financial institutions.

The cash rate directly impact on housing market of a nation. In this concern, if the cash rate increases than the housing market participants decreases borrowing from banks or financial institution. At high cash rate or interest rate they cannot afford the cost of borrowed money and will not be confident on investments. On the other hand, if the cash rate decreases than the capacity of borrowing of housing participants increases and they can afford to construct infrastructure in the country. The decreased cash rate may boost the housing market.

In Australia, the condition of housing market is extremely considerable but in the entire world condition of housing market fluctuated. The reason behind this considerable housing market in Australia is lower cash rate which have motivated to the property investors to contribute in the lending standards. Furthermore, there is a direct relation between cash rate, property prices, housing construction and employment because at the lower rates the property participants will be able to take more borrowings and invest it in construction, which will enhance construction jobs in the country. Therefore, the RBA has the objective of cutting cash rate to boost the employment and economy of the country. Hence, RBA should be concerned with rapid property price growth and investor borrowing when taking decision related to cash rate.

Transmission Mechanism

Monetary policy is essential to provide support a nation’s economy but it has some limitations. In this way, it is analyzed that the monetary policy does not take any guarantee of economic recovery. In global recession, the consumers will be less confident in spending that may impact to the nation economic in negative way. Moreover, it may take much time in implementing in compare to other policies like fiscal policy than can make flow of money faster in the economy.

The economists believed that the monetary rules are better policy than discretionary inflation targeting because discretionary inflation targeting focuses on determining in interest rate on supplied money but the rules of monetary policy is used to control supply of money with targeting the inflation rate to ensure the price stability. The monetary rules are more extensive in the economic scope as compare to discretionary inflation effect.

Conclusion:

From the above discussion it can be concluded that cash rate is an important element on which a country’s economic position depended. Different aspects such as employment, investment, inflation and deflation are depended on case rate decided by the nation’s central bank. Furthermore, it can also be concluded that the monetary policy has advantages for the economy but it has also some limitations.

Andoh, S.K. (2014) Essentials of Money, Banking and Financial Institutions: With Applications to the Developing World. UK: Lexington Books.

Bindseil, U. (2014) Monetary Policy Operations and the Financial System. UK: Oxford University Press.

Kashkari, N (2016) The Role and Limitations of Monetary Policy. [Online]. Available at: https://www.minneapolisfed.org/~/media/files/news_events/pres/kashkari-remarks-ecom-05-09-16.pdf (Accessed: 6 June 2017).

Kent, C. (2017) ‘Uncertainty and Monetary Policy.’, Australian Economic Review, 50(1), pp.85-88.

Kim, S. and Mehrotra, A. (2017) ‘Managing price and financial stability objectives in inflation targeting economies in Asia and the Pacific.’, Journal of Financial Stability, 29, pp.106-116.

Mata, M. (2017) How the housing market impacts the RBA’s interest rate decisions. [Online]. Available at: https://www.yourmortgage.com.au/article/how-the-housing-market-impacts-the-rbas-interest-rate-decisions-233762.aspx (Accessed: 6 June 2017).

Moore, A. (2017) ‘Measures of Inflation Expectations in Australia.’, The Sensitivity of Personal Income to GDP Growth 1 Factors Affecting an Individual’s Future Labour Market Status 11 Measures of Inflation Expectations in Australia 23 The Cash Market 33 The Future of Cash 43, p.23.

Rabanal, P. and Bracons, O.A. (2011) The Effects of Housing Prices and Monetary Policy in a Currency Union.

RBA (2017) Cash Rate. [Online]. Available at: https://www.rba.gov.au/statistics/cash-rate/ (Accessed: 5 June 2017).

RBA (2017) Our Role. [Online]. Available at: https://www.rba.gov.au/about-rba/our-role.html (Accessed: 6 June 2017).

Robinson, T., Nguyen, V.H. and Wang, J. (2017) ‘The Australian Economy in 2016–17: Looking Beyond the Apartment Construction Boom.’, Australian Economic Review, 50(1), pp.5-20.

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