Integrated Programme in Management

Indian Institute of Management Indore

Monetary Policy

RESERVE BANK OF AUSTRALIA

Submitted by:

Group - 5

Hardik Israni 2021IPM048

Kushal Somani 2021IPM073

Shaurya Khemka 2021IPM123

Inflation Targeting in Australia: Introduction

The Reserve Bank of Australia (RBA) implemented its Inflation Targeting Policy in 1993 in
response to soaring rates of inflation that had severely impacted the Australian economy
throughout the 1970s and a significant part of the 1980s. This policy was aimed at
maintaining a low and stable rate of inflation, which was typically supposed to be around 2-
3%, by adjusting interest rates in response to changes in the economy.

The RBA's inflation target range is consistent with the international standard adopted by
many other central banks worldwide, and it provides a clear framework for the RBA's policy
decisions. This range also provides certainty to the public and financial markets about the
RBA's objectives.

The RBA employs a variety of measures to achieve its inflation target, including setting the
official repo rate. In situations where inflation is too high, the RBA seeks to increase the
official repo rate to reduce borrowing and spending in the economy, which, in turn, reduces
demand and leads to a decline in price levels. Conversely, when inflation is too low, the RBA
will decrease the official repo rate to stimulate borrowing and spending, which boosts
demand and hence increases prices.

The Inflation Targeting Policy of the RBA has been mostly successful in achieving the goals
of maintaining stability of the Australian dollar, ensuring full employment, and promoting
economic prosperity, which also happen to be the three pillars of RBA’s Inflation Targeting
Policy. This policy has helped to anchor inflation expectations, thereby reducing uncertainty
and encouraging long-term investment in the economy. Furthermore, It has helped to
maintain stable economic conditions, which supports sustainable economic growth.

In conclusion, the Inflation Targeting Policy is an integral component of Australia's economic

policy framework, providing a clear framework for the RBA's policy decisions and
promoting economic stability and growth. The policy has been successful in achieving its
objectives and has become a model for other countries seeking to adopt similar strategies.

Inflation Targeting in Australia: History

The period between 1970 and 1993 was a critical time for the Australian economy, marked
by several challenges and shifts in monetary policy. The Reserve Bank of Australia (RBA)
was responsible for managing the economy during this time, with three key objectives of
maintaining the stability of the Australian dollar, ensuring full employment, and promoting
economic prosperity for its citizens.

The 1970s were a challenging time for Australia, as the global oil price shock caused by
OPEC's decision to restrict oil supply had a significant impact on the country's economy. This
led to soaring rates of inflation, with Australia experiencing a peak inflation rate of 17.7% in
1974. This period was followed by a phase of disinflation, which lasted for several years,
before another less powerful oil price shock in the late 1970s led to a rise in inflation rates
again.

While inflation rates began to decline after reaching their peak in 1974, the issue of
unemployment became a critical challenge for the Australian economy post-mid-1980s and
early 1990s. Unemployment rates reached up to 11% in 1991, which led to a need for a
monetary policy that targeted inflation to maintain stability and ensure economic prosperity.

To address these challenges, the RBA adopted the Inflation Targeting Policy in 1993. This
policy aimed to maintain a low and stable rate of inflation by adjusting interest rates in
response to changes in the economy. The adoption of this policy has been successful in
achieving the goals of maintaining the stability of the Australian dollar, ensuring full
employment, and promoting economic prosperity.

Australian Economy Post the 90s and Response to Financial Crisis

One of the fundamental issues that were lying ahead of the RBA was the issue of
unemployment. It was in 1991, that Australia recorded an unemployment rate of 11%.
Furthermore, the inflation recorded the following year was practically negligible, being
recorded at a mere 0.3%. This figure was Australia’s lowest inflation in 30 years. In light of
this situation Australian planned on boosting the employment rate in Australia by inflation
targeting. As the prices of commodities went up, the firms started hiring more workers and
hence, unemployment came down. Moreover, this strategy is also highly useful when a
country is looking to boost its output.

It is since 1991, that the Australian economy has sustained operating on an inflation level of
2-3% by virtue of inflation targeting. Clear indication of inflation targeting by rule is evident
in the fact that the average rate of inflation in Australia stood at a mere 2.5% during its first
25 years of inflation targeting compared to the average inflation rate of 8.8% between 1970
and 1993. Furthermore, the CPI movements rarely crossed the 5% mark, thus, further
indicating the stability and the sound implementation of this policy.

Although the fluctuations in the inflation levels of Australia were usually minor and
insignificant, Australia did go under a period of deflation in 1997 as a result of the Asian
Financial Crisis. With decline in prices of imported goods and volumes exported to East Asia,
the AFC impacted the inflation rate in Australia for the next two years.

In light of the fact that this crisis had an impact on Australia in terms of affecting a significant
portion of its trade with other countries, the Reserve Bank of Australia used various tools,
such as devaluation of the Australian Dollar, and boosting inflation. The rationale behind
these policies and decisions by the Australian government can be understood by the fact that
Australia was experiencing a decline in exports which contributed to the widening of its
current account deficit. Given that devaluation of a currency makes exports cheaper for
citizens elsewhere, devaluation of the Australian currency can be recognized as a viable tool
to boost exports and reduce the current account deficit. Boosting inflation again is a highly
well recognized tool for increasing output and driving a country out of a state of recession.

Another period of concern that arose in this period was the global financial crisis of 2008. A
brief analysis of Australia’s monetary policy during this period indicates that it was swift,
effective, and helped massively in mitigating the impact of the crisis on the Australian
economy.

In response to the crisis, the RBA lowered its official repo rate from 7.25% in August 2008 to
3% in April 2009. The RBA also took additional measures including providing liquidity to
financial institutions, purchasing government bonds, and expanding its balance sheet.

These measures had a number of positive effects which greatly helped mitigate the adverse
effects of the financial crisis. Firstly, reducing the repo rate by 4.25%, decreased the rate of
interest to households significantly. This, particularly encouraged households, and businesses
to take credit which helped in boosting investment and consumption. Secondly, RBI’s
purchase of government bonds helped to stabilize financial markets and reduce volatility.

Although there were issues relating to high unemployment rates and high slowdown in
economic growth around the world, the impact of this crisis was less severe on Australia.
This was one of the main reasons why Australia managed to recover faster than other
countries around the world.

To provide concluding remarks on Australia’s policy in light of the various crises faced
between 1993 and 2018, one can only say that they took appropriate actions to mitigate the
adverse conditions that could have been intensified owing to the situations. Although one
might argue that shocks of these crises were relatively less severe on Australia, one can’t
discount the fact that Australia tackled its crises to the best of the stakeholders’ interests.

Open Market Operations: Introduction

Open Market Operations (OMOs) are one of the primary tools used by central banks to
influence the money supply and manage interest rates in an economy. OMOs involve the
buying and selling of government securities, such as bonds, by the central bank in the open
market.

The significance of OMOs lies in their ability to influence the money supply and interest
rates. When the central bank buys government securities in the open market, it injects cash
into the economy, increasing the money supply. Conversely, when it sells government
securities, it withdraws cash from the economy, decreasing the money supply. This buying
and selling of securities directly impacts the level of reserves that banks hold, and thus their
ability to lend.

By adjusting the supply of money in the economy, central banks can also influence interest
rates. When the money supply increases, interest rates tend to fall, making borrowing cheaper
and stimulating economic activity. Conversely, when the money supply decreases, interest
rates tend to rise, making borrowing more expensive and slowing economic activity.

OMOs also play a critical role in implementing monetary policy. Central banks use OMOs to
achieve their target interest rate or other monetary policy objectives, such as maintaining
price stability or promoting economic growth. For example, if the central bank wants to
reduce interest rates, it can buy government securities, increasing the money supply and
putting downward pressure on interest rates.

OMO in the Australian Context

The Reserve Bank of Australia is responsible for the designing and execution of the monetary
policy in Australia. The decisions of the Board are implemented by the bank by taking part in
Australia's domestic financial market and smoothen the payments systems.

One of the main decisions taken by the RBA is about the cash rate. The cash rate is the rate
charged by the banks for inter-bank transactions that happen overnight. It is calculated as the
weighted average of the interest rate at which overnight unsecured funds are transacted in the
domestic interbank market (the cash market).

Before 2020, the cash rate was the sole operational target for the RBA and all the open
market operations were aimed at maintaining this cash rate equal to the target rate in order to
ensure optimum liquidity in the economy.

However, after 2020, some additional policy measures were introduced by the Reserve Bank
of Australia. The primary reason behind this step was the lowering of cash rates due to
increased liquidity in the economy. Two of the significant policy measures were purchasing
of Government Bonds and a Term Funding Facility.

Purchasing of Government Bonds

The Reserve Bank of Australia purchases the government securities which usually have a
maturity period of greater than 18 months. Before March 2020, these operations were carried
out quarterly and in relatively small quantities. However, since March 2020, the bank has
purchased Australian Government Securities (AGS) regularly for monetary policy purposes,
including supporting a yield target and lowering longer-term yields. The bond purchase
program consisted of 80% AGS and 20% semi-government securities, with purchases
conducted through multi-price auctions on Mondays, Wednesdays, and Thursdays. The bank
monitored the impact of purchases on market functioning and was prepared to adjust auctions
as necessary. The program excluded recently tapped or newly issued bonds, and the bank was
prepared to purchase securities to address market dislocations. The yield target was
discontinued on November 2, 2021, and purchases under the bond purchase program ceased
on February 10, 2022.

Term Funding Facilities

The Term Funding Facilities was an initiative by the Reserve Bank of Australia to provide
funding for a period of 3 years to the Authorized Deposit taking Institutions (ADIa) to
combat the aftereffects of the pandemic. The Term Funding Facilities had two primary
objectives. The first objective was to enable the economy to avail the benefits of a lower cash
rate by reducing the funding costs of ADIs, which in turn, reduces the borrowing costs of the
general public. The second objective was to motivate the ADIs to aid businesses in the
country during the economic downturn.

Liquidity: Introduction

Liquidity refers to the availability of cash or other assets that can be easily converted into
cash without affecting their value. Maintaining liquidity in the economy is crucial for the
smooth functioning of financial markets, as it ensures that banks and other financial
institutions have access to the cash, they need to meet their obligations and lend to businesses
and individuals. A central bank plays a vital role in maintaining liquidity in the economy
through various monetary policy tools, including open market operations, discount lending,
and reserve requirements.

One of the primary ways central banks maintain liquidity in the economy is by providing
loans to banks and other financial institutions through discount lending. During times of
financial stress or economic downturns, banks may experience liquidity shortages, making it
difficult for them to meet their obligations or lend to others. In such situations, central banks
can lend to these institutions, providing them with the cash they need to continue their
operations and avoid a broader financial crisis.

Central banks may also set reserve requirements, which mandate that banks hold a certain
percentage of their deposits as reserves. Central banks can adjust the reserve requirement to
increase or decrease the level of liquidity in the economy. For example, if the central bank
wants to increase liquidity and encourage lending, it can lower the reserve requirement,
which allows banks to hold less cash in reserve and frees up more money to be lent out.
Conversely, if the central bank wants to decrease liquidity and reduce inflationary pressures,
it can raise the reserve requirement, which forces banks to hold more cash in reserve and
reduces the amount of money available for lending.

Another way central banks use reserve requirements to maintain liquidity is by adjusting the
type of assets that can be used to satisfy the reserve requirement. For example, a central bank
may allow banks to use government bonds or other high-quality assets to satisfy their reserve
requirement, which provides a source of liquidity that banks can tap into if needed. This
approach increases the availability of cash in the financial system and can help prevent
liquidity shortages.

CLF - A strategy by Australian reserve bank

Since January 2015, Australian Depository Institutions (ADIs) that are subject to the Basel III
liquidity standards have been required to hold high-quality liquid assets (HQLA) sufficient to
withstand a 30-day period of stress under the liquidity coverage ratio (LCR) requirement.
However, the only assets recognized as HQLA in the Australian dollar securities market are
Australian Government Securities (AGS) and securities issued by the borrowing authorities
of the states and territories (semis). Historically, a large proportion of the current stock of
AGS and semis on issue has been held by non-residents, and ADIs' holdings have been well
below the amount that would be needed if all ADIs were to meet their LCR requirement
through this means.

To address this issue, the Reserve Bank and APRA developed an alternative treatment known
as the Committed Liquidity Facility (CLF). Under this arrangement, certain ADIs were
able to use a contractual liquidity commitment from the Reserve Bank towards meeting their
LCR. The size of the CLF in each year was the difference between APRA's assessment of the
overall LCR requirements of locally-incorporated ADIs and the Reserve Bank's assessment
of the amount of AGS and semis that could reasonably be held by these ADIs without unduly
affecting market functioning.

In practice, the CLF did not change the way ADIs access the Reserve Bank's existing
standing facilities. The only difference is that in the absence of a CLF the Reserve Bank has
made no contractual commitment ahead of time to transact repos with any ADI under its
standing facilities; each individual repo is subject to the Reserve Bank's agreement. The CLF
provided a means by which ADIs could obtain a contractual commitment from the Reserve
Bank to extend funding subject to certain conditions. In particular, the Reserve Bank's
commitment was always contingent on the ADI having positive net worth in the opinion of
the Reserve Bank, following consultation with APRA.

The CLF allowed ADIs to hold towards their LCR requirement securities eligible in the
Reserve Bank's operations that are not HQLA securities, provided a fee was paid on the CLF
amount. As noted above, the Reserve Bank was willing to accept as collateral certain other
debt securities (in addition to AGS and semis) in its operations. As is its standard practice, the
RBA applied haircuts to the securities available to be presented, such that ADIs needed to
hold securities with a higher value than the size of the CLF.

However, CLF was discontinued by the RBA by the end of 2022. According to a letter seny
by APRA, this step was taken because the RBA and the APRA both expected the ADIs to
have sufficient HQLAs by the end of 2022, to meet their LCR requirements without the need
to utilize the CLF. But APRA has said that it will continue to monitor the condition and will
reintroduce the CLF if the situation demands so.

Forex Market Interventions

Foreign exchange market interventions are significant for a central bank of a country because
they can be used as a tool to influence the value of the country's currency in the foreign
exchange market. By intervening in the foreign exchange market, a central bank can either
buy or sell its own currency against another currency. The decision to intervene is usually
based on the central bank's monetary policy objectives and the need to maintain a stable
exchange rate.
One of the primary reasons a central bank may choose to intervene in the foreign exchange
market is to address dysfunction and/or significant misalignment in the value of the country's
currency. This could occur if the currency is experiencing large fluctuations or if there is a
significant appreciation or depreciation of the currency that could harm the country's
economy. In such cases, a central bank may intervene to restore stability to the exchange rate
and prevent economic instability.

Another reason a central bank may intervene in the foreign exchange market is to manage the
level of its foreign currency holdings. This can be done through the use of foreign exchange
swaps or outright purchases or sales of foreign currency. The central bank may choose to
increase or decrease its foreign currency holdings based on its monetary policy objectives and
to manage the overall risk profile of its balance sheet.

Foreign exchange market interventions can also be used to achieve broader policy objectives
such as promoting economic growth, reducing inflation, and maintaining financial stability.
For example, a central bank may intervene to lower the value of its currency in order to boost
exports and promote economic growth, or it may intervene to raise the value of its currency
in order to reduce inflation and maintain financial stability.

However, foreign exchange market interventions also carry risks for a central bank. For
instance, interventions can be expensive and may not always be effective in achieving the
desired outcome. There is also the risk of creating volatility in the market or sending mixed
signals to market participants. Additionally, if a central bank intervenes too frequently or too
aggressively, it may risk losing credibility in the market and undermine its ability to influence
the exchange rate in the future.

Forex Market Interventions in the Australian Conext

The Reserve Bank of Australia occasionally engages in foreign exchange transactions to

influence the exchange rate or to manage the level of its foreign currency holdings. Australia
has a floating exchange rate regime, which means that the exchange rate is determined by the
market forces of supply and demand. However, the Reserve Bank retains the discretion to
intervene in the foreign exchange market if there is a significant misalignment in the value of
the Australian dollar or if there is dysfunction in the market. These transactions are usually
done in the spot market, and data on daily foreign exchange intervention can be found on the
Bank's website with a lag.

The Reserve Bank of Australia also engages in foreign exchange transactions to manage the
level of its foreign currency holdings. These transactions are different from intervention in
that they are executed in a way that minimizes their impact on the exchange rate and market
conditions. They are typically executed in the spot market in small amounts over long
periods. The Reserve Bank uses foreign exchange swaps to obtain foreign currency that can
be used to meet Australia's commitments as a member of the International Monetary Fund
(IMF). A foreign exchange swap involves exchanging one currency for another with a
commitment to unwind the exchange at a subsequent date at an agreed forward exchange
rate. The Reserve Bank executes foreign exchange swaps against Australian dollars for
periods of up to five years. The use of foreign exchange swaps by the Reserve Bank does not
change its outright foreign currency position and has no implications for the value of the
Australian dollar.

Overall, while the Reserve Bank of Australia's foreign exchange transactions are intended to
influence the exchange rate or manage its foreign currency holdings, they are only done when
dysfunction or significant misalignment in the market occurs. The Reserve Bank typically
minimizes the impact of these transactions on the exchange rate and market conditions, and
the use of foreign exchange swaps has no direct implications for the value of the Australian
dollar.

Reserves Management

Australia's official reserve assets consist of foreign currency assets, gold, Special Drawing
Rights (SDRs), and Australia's reserve position in the International Monetary Fund (IMF).
These assets are owned and managed by the Reserve Bank of Australia, with the exception of
Australia's reserve position in the IMF, which is owned by the Australian Government. The
Reserve Bank's foreign currency assets are mainly held to facilitate its policy operations in
the spot foreign exchange market, as well as to meet Australia's IMF commitments. However,
outright holdings of foreign currency assets expose the Bank's balance sheet to foreign
currency risk, and may carry interest rate, credit, and liquidity risks.

The Bank publishes data on its official reserves, which includes a measure of its foreign
currency assets that deducts net foreign currency commitments due within the next 12
months. These short-term net foreign currency commitments capture foreign currency that the
Bank is due to deliver under swap agreements maturing within the next 12 months. The Bank
can add to its foreign currency liquidity position either by obtaining foreign currency in the
spot market or via longer-term swaps.

The management of Australia's reserves requires investments in assets of high credit quality,
with sufficient liquidity to meet the Bank's policy objectives. The investment process for
outright holdings of foreign currency assets is guided by an internal benchmark, which
represents the Reserve Bank's best estimate of the combination of foreign currency
investments that maximizes return over the long run, subject to an acceptable level of risk and
the overarching requirements for security and liquidity.

Investments within the benchmark currencies are limited to deposits at official institutions
(such as central banks) and debt instruments issued (or guaranteed) by sovereign, quasi-
sovereign, and supranational entities. Sovereign credit exposures are limited to nine
countries, including the United States, Germany, France, the Netherlands, Canada, Japan, the
United Kingdom, China, and South Korea. Additionally, the Reserve Bank has investments in
a number of Asian debt markets through participation in the EMEAP Asian Bond Fund
(ABF) Initiative, which was established to assist in the development of bond markets in the
region in the wake of the Asian currency crisis in the late 1990s.

The Reserve Bank retains the discretion to intervene in the foreign exchange market to
address dysfunction and/or a significant misalignment in the value of the Australian dollar.
The Bank provides data on daily foreign exchange intervention on its website (with a lag).
However, intervention by the Bank has become less frequent over time, as the market has
developed, hedging foreign currency risk has become more efficient, and as awareness of the
benefits of a floating exchange rate regime has grown. Transactions undertaken for these
purposes would usually be affected in the spot market.

In conclusion, the Reserve Bank of Australia manages Australia's official reserve assets,
including foreign currency assets, gold, SDRs, and Australia's reserve position in the IMF.
The Bank holds foreign currency assets mainly to facilitate its policy operations in the spot
foreign exchange market and meet Australia's IMF commitments, and investments in these
assets are guided by an internal benchmark that prioritises credit quality, security, and
liquidity. The Bank retains the discretion to intervene in the foreign exchange market to
address dysfunction or significant misalignments in the value of the Australian dollar, and
transactions undertaken for these purposes would usually be affected in the spot market.

The Taylor Rule:

The Taylor rule was proposed by an economist named John B. Taylor in the early 1990s. It is
a monitory policy tool that suggests the Central Banks, the adjustment to be made in interest
rates in response to the changes in inflation, output gap, which is the difference between
actual and targeted GDP, and other economic indicators. Specifically, the Taylor Rule states
that the central bank should set the nominal interest rate as a function of the inflation rate and
the output gap. The rule can be expressed mathematically as:

i=r*+π*+1.5(π- π*)+0.5(Y−Y∗)

i= nominal interest rate

r*= real targeted interest rate

Y= actual output

Y*= targeted output

π= inflation rate

π*= targeted inflation rate

The coefficients of 1.5 and 0.5 are empirically observed and econometrically measured.

The rationale behind the rule is that higher interest rates help in cooling down the economy
and vice-versa. Through the Taylor Rule, Central Banks can keep the inflation rate around the
target level ensuring price stability, and promote economic growth by adjusting interest rates
in response to changes in the economy.

Brouwer and Regan (1997) conducted a study aimed at

evaluating different monetary policy rules for Australia.
They came up with the conclusion that Taylor rule is
best among all the simple policy rules as it yields the
minimum output and inflation variability among all. The
same has been reflected in the graph attached. Further,
Source: De Brouwer, G., & O'Regan, J. (1997).
they discussed how the Taylor Rule is much more efficient in promoting the stability in
output as well as inflation.

Taylor Rule in the Australian Context:

Hudson and Vespignani (2015) examined the application and effectiveness of the Taylor Rule
in Australia. Reserve Bank of Australia (RBA) has explicitly referred to the Taylor Rule in its
monetary policy statements. The RBA has also used the Taylor Rule as a benchmark for
assessing the appropriate level of interest rates.

The authors examined the implementation of Taylor Rule for Australia. They used the
quarterly data from 1991 to 2014 for estimating the rule. Three types of inflation rates
including the headline CPI inflation, trimmed mean CPI inflation, and weighted median CPI
inflation were used for the study for making it more robust. Along with that, three different
parameters were also taken to calculate the output gap. On the basis of several parameters, an
OLS as estimated and tested for. The results though did not comply very much to the Taylor
Rule estimates. The coefficient for output gap comes out to be much less than the 0.5
estimated by Taylor. However, the value is still positive and statistically significant. All nine
estimates agree that the sum of the interest rate smoothing parameters is statistically
significant and all their values fall between 0.83 and 0.85. This suggests that in the past, the
RBA aspired to smooth the changes in cash rate or respond to factors that are not a part of the
Taylor Rule equation. The best fit that was made using the trimmed mean inflation showed
the following difference in the predicted value and the actual value of the cash rate. The
following figure illustrates that:
Source: Hudson, K., & Vespignani, J. L. (2015)

The above graph, highlighting the deviations of Taylor Rule estimates from actual cash rate,
shows that the deviations have remained marginal in their magnitude except during the period
of the Great Financial Crisis, when the RBA took action to make money easier to borrow.
Between 2011Q4 and 2013Q1, the Taylor Rule said that interest rates were always higher
than the cash rate target. This meant that the policy was "accommodative." As shown by
central banks around the world, including Australia's, after the GFC, this loose monetary
policy may have been an attempt to boost economic activity and pay less attention to
inflation.

Statistically discussed, approximately 65% of the deviation can be explained using the
various domestic as well as international factors. The domestic interest rate, which is the only
domestic factor accounts for around 22.5% of the deviation. Remaining domestic factors like
employment and real output are not important in the determination of this deviation. On the
other hand, various international factors such as exchange rates, international interest rates,
commodity prices, and US’ deviation from its estimated Taylor rules are able to significantly
explain around 42% of the deviation. These results are indicative of the fact that the RBA is
affected by external trends, specially that of US’.

Monetary Policy of Australia in the Covid Era

The economic environment in Australia was characterised by feelings of uncertainty as the
covid 19 pandemic posed a significant threat to economies worldwide. The high volatility of
the economic environment was evident by the disruption of global supply chains, which led
to increased inflationary pressures.

In a situation where nations around the world struggled to ensure prosperity for their citizens
in the covid 19 pandemic, the Reserve Bank of Australia implemented various measures to
ensure that there is a healthy balance between concern for public health and economic
support.

With declining economic activity as businesses were shut down and consumer spending
sharply declined, there was a significant fall in the level of inflation in Australia. This can be
fundamentally attributed to the fact that there was little to no demand for a majority of
consumer goods, and that creation of demand for these mandated a reduction in prices.

In response to these challenges, the Reserve Bank of Australia introduced various measures
to support the economy and attain price stability. The first measure taken by the RBA in this
regard was to reduce the repo rate (The rate at which the central banks lend money to the
commercial banks) to a nominal level (0.10%). The fundamental motive behind this measure
was to provide low-cost funding so that they can be further encouraged to offer low interest
loans to households and businesses. Given that lack of demand for goods, and lack of credit
to finance limited business activities was one of the major concerns of the Australian citizens,
the reduction of repo rates is one measure that particularly worked well.

Another key measure taken by the RBA was the purchase of government bonds (Under the
government’s quantitative easing program). The fundamental aim of this purchase strategy
was to ensure that the interest rates are kept low owing to the lack of supply of bonds in the
market. Owing to the fact that the final effect of this measure was to reduce borrowing costs
among the households, this was one of the key solutions to support the economy.

These measures taken by the RBA to support the economy during the pandemic have had a
significant impact on inflation. In the early stages of the pandemic, inflation fell significantly
below the RBA's target range, with the annual headline inflation rate reaching just 0.3% in
the September quarter of 2020. This was due to a range of factors, including lower energy
prices, reduced demand for non-essential goods and services, and the impact of government
policy measures such as free childcare and freeze on some public fees.
Although the entire idea behind the need to go for a monetary policy that was centered
around low rates of inflation and borrowing rates, mostly seemed favorable for most of the
general public there are criticisms for the approach the Reserve Bank of Australia adopted in
the pandemic.

Firstly, RBA's inflation targeting policy during the COVID-19 pandemic is that it may have
become less relevant. With economic activity severely disrupted by the pandemic, the usual
relationship between inflation and economic growth had been severely disrupted, making it
difficult to achieve the inflation target. Furthermore, the RBA's monetary policy measures,
such as QE ( Quantitative Easing) and cutting interest rates, had limited impact on the
economy due to the unique circumstances of the pandemic.

Furthermore, the RBA's policy response to the pandemic has primarily focused on stabilizing
financial markets and supporting economic growth, rather than specifically targeting
inflation. While this is understandable given the severity of the pandemic's impact on the
economy, it has led to a situation where the RBA is not meeting its inflation target, which
could lead to longer-term inflation expectations drifting lower. In light of this criticism,
various economists had argued that economic activity could have been motivated by direct
fiscal expenditure by the government.

Furthermore, one of the potential criticisms of the Australian monetary policy in the covid era
can be linked to the fact that it widened wealth inequality among its citizens. The decrease in
the interest rates was highly favorable to asset holders, as there was a rise in stock and
property prices. Although this policy was highly favorable to asset owners, little to no benefit
was offered to those with low income or no assets. In light of the same, one may argue that
owing to these effects, the Australian monetary policy exacerbated economic inequality.

Finally, inflated prices of assets, without underlying fundamentals are highly undesirable as
they lead to the creation of an asset bubble. The dotcom bubble in the 1990s, and the real
estate bubble in the 2000s which led to the biggest financial crisis of the century in 2008
provide for empirical evidence justifying the massive threat that these bubbles can pose to an
economy.

To provide concluding remarks on Australia’s monetary policy in the covid era, one can only
say that the RBA managed its threats fairly well considering the severity of the situation
worldwide. The main focus of their policy was focused on achieving stability in the country’s
economic activities and ensuring prosperity of its citizens. Although there have been
limitations as Australia has been unsuccessful in achieving its inflation targets, their policy
was successful in achieving a majority of their objectives and has become a model for other
countries seeking to adopt similar strategies.

References

Hudson, K., & Vespignani, J. L. (2015). Understanding the Taylor Rule in Australia.
https://mpra.ub.uni-muenchen.de/104679/1/MPRA_paper_104679.pdf

De Brouwer, G., & O'Regan, J. (1997). Evaluating simple monetary policy rules for
Australia. The Australian National University.
https://www.rba.gov.au/publications/confs/1997/pdf/de-brouwer-oregan.pdf

International Market Operations. (n.d.). Reserve Bank of Australia.

http://www.rba.gov.au/mkt-operations/intl-mkt-oper.html

CLF Operational Notes. (2019, July 7). Reserve Bank of Australia.

http://www.rba.gov.au/mkt-operations/resources/tech-notes/clf-operational-notes.html

CLF Operational Notes. (2019, July 7). Reserve Bank of Australia.

http://www.rba.gov.au/mkt-operations/resources/tech-notes/clf-operational-notes.html

Domestic Market Operations and Liquidity Facilities. (n.d.). Reserve Bank of Australia.
http://www.rba.gov.au/mkt-operations/domestic-market-ops-and-standing-facilities.html

Term Funding Facility. (n.d.). Reserve Bank of Australia. http://www.rba.gov.au/mkt-

operations/term-funding-facility/overview.html
Battellino, R., Broadbent, J., & Lowe, P. (1997). The Thinking Underlying Current
Arrangements| RDP 9703: The Implementation of Monetary Policy in Australia. Reserve
Bank of Australia Research Discussion Papers, (July).
https://www.bis.org/publ/confp03i.pdf

70 Years of Inflation in Australia. (n.d.). 70 Years of Inflation in Australia | Australian

Bureau of Statistics. https://www.abs.gov.au/statistics/research/70-years-inflation-australia

Inflation Target. (n.d.). Reserve Bank of Australia. http://www.rba.gov.au/inflation/inflation-

target.html

The Asian Crisis and the Reserve Bank | Reserve Bank of Australia Annual Report –
1998. (1998, January 1). Reserve Bank of Australia.
http://www.rba.gov.au/publications/annual-reports/rba/1998/asian-crisis.html