AOS1: Monetary Policies

• Budgetary Policy?

  Government tax and non-tax revenue/expenses
• Monetary Policy?

  Manipulation of interest rates
• Role of budgetary/monetary policies?

  Stabilising the business cycle.

  • Budgetary has a supporting role
  • Monetary deals with short term fluctuations in Business cycle
• Monetary Policy Goals?

  • Stability of Currency (Goal of Low inflation)
  • Maintenance of Full employment goal
  • Economic prosperity & welfare of people
• Order of RBA -> Interest rates?

  RBA, in the overnight market, change cash rate via supply of cash via OMO (Common wealth Security buying/selling), affecting banks Exchange Settlement Accounts, who then change commercial interest rates to maintain profit margins
• Exchange settlement accounts?

  Account that commercial banks hold with the RBA

  
  

  Balanced out via lending and loaning of funds between banks
• Fill in the labels

  A) Overnight Market

  B) Lending Rate

  C) Deposit Rate

  D) Policy Interest rate corridor

  E) cash rate target

  
• What is the lending rate?

  Cash rate target + 0.25% (25 base points)
• What is the deposit rate?

  Cash rate target - 0.1% (10 base points)
• What is the floor and ceiling of the overnight market?

  Floor = Deposit rate

  Ceiling = Lending rate
• Equilibrium price in Overnight market graph?

  Cash Rate Target
• What happens when the RBA sells commonwealth securities?

  Supply of cash decreases

  CRT increases
• What happens when the RBA buys commonwealth securities?

  Supply of cash increases

  CRT decreases
• Type of Unconventional Monetary Policy?

  Forward Guidance
• Types of Forward Guidance?

  Time-Based guidance

  • policy stays until a certain date/time

  State-Based guidance

  • policy stays until a specific economic condition is met
• What is the reason for Unconventional Monetary Policies?

  Provide stability and predictability, and reduce uncertainty about unusual economic/financial outlooks
• Transmission of Monetary Policies?

  How the change in cash rate/interest rates affects change in economic activity and inflation
• Transmission of Monetary Policies Flows?

  1. Savings and investment
  2. Cash Flow
  3. Exchange Rates
  4. Wealth and Asset prices
• Transmission of monetary policies -> SAVINGS AND INVESTMENT

  
  

  • Changes incentive to save (leakage) and borrow new debt (injection)

  
  

  Interest rates changes reward for saving/cost for borrowing

  changes saving and borrowing rates

  Changes "C" and "I"

  Thus it changes AD
• Transmission of monetary policies -> CASH FLOW?

  • for people with VARIABLE loans (interest rate changes)

  Interest rates changes their discretionary income (income after tax)

  Changes "C" and "I"

  Thus it changes AD
• Transmission of monetary policies -> EXCHANGE RATES?

  • Relative interest rates and foreign investors incentive to deposit money in AUS

  Interest rates changes incentive for foreign investors to deposit money into AUS

  Changes demand for AUD

  Depreciation or Appreciation of AUD

  Changes incentive for Exports (X)

  Thus it changes AD
• Transmission of monetary policies -> WEALTH & ASSET PRICE?

  • Wealth effect -> ppls perception of their wealth based on the price increase/decrease of their assets (ie: Houses)

  Interest rates changes reward for saving/cost for borrowing

  changes saving and borrowing rates

  Changes demand for Assets (if borrowing increases/decreases, then demand for assets increases/decreases)

  Thus wealth effect takes place, changing "C" & "I"

  Hence changing AD
• Stance of Monetary Policy?

  Neutral Interest rate refers to the rate where there is no contractionary or expansionary pressures.
• Label the Monetary Policy Neutrality Graph

  A) More Contractionary (Tightening)

  B) Less Contractionary (Loosening)

  C) More Expansionary (Loosening)

  D) Less Expansionary (Tightening)

  
• Strengths of Monetary Policy?

  1. No Bias
  2. Short Implementation Lag
  3. Large influence on economic agents & AD/Discretionary income
  4. Use of unconventional policies allows for flexible decisions
• Weaknesses of Monetary Policy?

  1. Blunt (changes affect everything, not specific areas of concern)
  2. Long Impact Lag (takes a while for impact to be seen)
  3. Indirect control on interest rates (as they control cash rates)
  4. Exchange rate channel is ineffective (if foreign countries interest rates change as well)
  5. Can't directly change "cost inflation" (as they affect AD, not supply side conditions)
  6. Not super effective at changing AD (As they can't directly control consumers to spend more when interest rates decrease)
• Policy interest rate corridor?

  Describes the limits that banks can borrow and deposit cash at. ie: Deposit rate (floor - 10 bases points lower than CRT) and Lending rate (ceiling - 25 ceiling points higher than CRT)
• Define Unconventional Monetary Policies?

  When the RBA uses methods other than a direct change to the cash rate, to stimulate the economy
• Forward guidance?

  When the RBA provides information to economic agents (state or time based) to provide stability, predictability, and reduce uncertainty in unusual times.
• Process of tightening/loosening conventional monetary policies process?

  RBA provides statement of new target cash rate

  CRT changes, which moves the policy interest rate corridor
• Transmission of Monetary Policy Process?

  1. Changes to the cash rate flow through to interest rates in the economy
  2. Changes to these interest rates affect economic activity and inflation