Monetary Policy

Source http://www.rba.gov.au/
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. While making official interest rate decision RBA takes into account domestic
and international macroeconomic factors (related to major trading partners) such as
inflation unemployment, GDP growth rate, exchange rate, government debt, current
account deficit, housing market, international trade mining and manufacturing sectors. 3
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 28 months
until December 2018.

Media Release Statement by Philip Lowe, Governor: Monetary Policy Decision Date 4-
December-2018 https://www.rba.gov.au/media-releases/2018/mr-18-31.html

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

The global economic expansion is continuing and unemployment rates in most advanced
economies are low. There are, however, some signs of a slowdown in global trade, partly
stemming from ongoing trade tensions. Growth in China has slowed a little, with the
authorities easing policy while continuing to pay close attention to the risks in the financial
sector. Globally, inflation remains low, although it has increased due to the earlier lift in oil
prices and faster wages growth. A further pick-up in core inflation is expected given the tight
labour markets and, in the United States, the sizeable fiscal stimulus.

Financial conditions in the advanced economies remain expansionary but have tightened
somewhat. Equity prices have declined and credit spreads have moved a little higher. There
has also been a broad-based appreciation of the US dollar this year. In Australia, money-
market interest rates have declined, after increasing earlier in the year. Standard variable
mortgage rates are a little higher than a few months ago and the rates charged to new
borrowers for housing are generally lower than for outstanding loans.

The Australian economy is performing well. The central scenario is for GDP growth to
average around 3½ per cent over this year and next, before slowing in 2020 due to slower
growth in exports of resources. Business conditions are positive and non-mining business
investment is expected to increase. Higher levels of public infrastructure investment are also
supporting the economy, as is growth in resource exports. One continuing source of
uncertainty is the outlook for household consumption. Growth in household income
remains low, debt levels are high and some asset prices have declined. The drought has led
to difficult conditions in parts of the farm sector.

Australia's terms of trade have increased over the past couple of years and have been
stronger than earlier expected. This has helped boost national income. Most commodity
prices, however, have declined recently, with oil prices falling significantly. The Australian
dollar remains within the range that it has been in over the past two years on a trade-
weighted basis.

The outlook for the labour market remains positive. The unemployment rate is 5 per cent,
the lowest in six years. With the economy expected to continue to grow above trend, a
further reduction in the unemployment rate is likely. The vacancy rate is high and there are
reports of skills shortages in some areas. The stronger labour market has led to some pick-
up in wages growth, which is a welcome development. The improvement in the economy
should see some further lift in wages growth over time, although this is still expected to be a
gradual process

Inflation remains low and stable. Over the past year, CPI inflation was 1.9 per cent and in
underlying terms, inflation was 1¾ per cent. Inflation is expected to pick up over the next
couple of years, with the pick-up likely to be gradual. The central scenario is for inflation to
be 2¼ per cent in 2019 and a bit higher in the following year.

Conditions in the Sydney and Melbourne housing markets have continued to ease and
nationwide measures of rent inflation remain low. Credit conditions for some borrowers are
tighter than they have been for some time, with some lenders having a reduced appetite to
lend. The demand for credit by investors in the housing market has slowed noticeably as the
dynamics of the housing market have changed. Growth in credit extended to owner-
occupiers has eased to an annualised pace of 5–6 per cent. Mortgage rates remain low, with
competition strongest for borrowers of high credit quality.

The low level of interest rates is continuing to support the Australian economy. Further
progress in reducing unemployment and having inflation return to target is expected,
although this progress is likely to be gradual. Taking account of the available information,
the Board judged that holding the stance of monetary policy unchanged at this meeting
would be consistent with sustainable growth in the economy and achieving the inflation
target over time.

Executive Summary
The terms of trade in Australia has enhanced over the past two years and stronger as
expected. This has enabled to boost the national income. Further, the Australia dollar
remained under a range thereby signalling that the economy is performing well. The overall
report rests upon the monetary policy, and the role played by the RBA. The report initiates
with the introduction followed by the main functions of monetary policy and role performed
by RBA. Further, the money market equilibrium is then discussed and progresses towards
the discussion of the cash rate. Moreover, the debate spread to the unchanged cash rate.
Lastly, economic growth is considered and defined.

Introduction
The Reserve bank must ensure that the monetary policy is under control and the economy is
devoid of undue pressure. The most important function is to attain the system of stability of
price, full employment attainment of the economic prosperity. The RBA board meeting 11
times in a year and before the initiation of the meeting the board members are given the
economic evaluation. The RBA monetary policy completely rests on such assessment. From
the discussion, it is noted that the common adjustments undertaken are that of 0.25
percent. The cash rate of Australia stands at a historic low of 1.50 percent since 2016. In
2016, there was a cut in the cash rate by 0.25 basis point that remained unaltered till August
2016. From the case study, it is noted that the Board left the cash rate unchanged at 1.50
percent. This was because the economy of Australia is performing is a dangerous manner.
Since the business condition is a positive and non-mining investment of business is
expected to enhance. Hence, considering the overall factors the decision to leave the cash
rate unchanged was justified.

1. Objectives of monetary policy Macroeconomics Case Study : Monetary policy

can be defined as that mechanism that helps in ensuring an operation that is effective and
pertains to the economic system or set of specific aims through the influence on the supply,
cost, as well as money availability. By monetary policy, it can be said that conscious action is
undertaken by the monetary authorities to alter the quantity, availability or money cost. The
monetary policy in the developed economies, function as a stabilizer and helps in
maintaining proper equilibrium. While in the case of underdeveloped countries, the
monetary system is more pronounced that assists in meeting the need of the economy that
is expanding that creates a proper condition for the progress of the economy. It is
ascertained that monetary policy acts as a potent tool when it comes to the concept of
transformation of the economy (RBA, 2018). The objectives of the monetary system are as
follows:

The rapid growth of the economy – It can be defined as the main aim of the monetary
policy. It enhances the growth of the economy by the control of the real interest rate and the
impact on the investment. If the RBI considers a cheap or easy credit policy by lessening the
interest rate, the investment level can be enhanced. The enhanced investment leads to
acceleration of economic growth (Pennings et. al, 2015). Faster economic growth can be
possible when the monetary policy maintains stability regarding income and price.

Stability of price - Economic scenario is prone to inflation, as well as deflation. It is even

termed as price instability. Both increases prove to be a disadvantage to the economy as a
whole. Therefore, the monetary policy has the sole motto to stabilize the prices in the
economy and try to keep the value of money stable in nature (Pennings et. al, 2015).

Money can be ascertained and commented on having three major function that is the
medium of exchange, store of value and the unit of account.

The medium of exchange - Money’s vital function is to enhance the transactions and
hence, termed as a medium of exchange. It leads to the abolition of barter where ample
difficulties were observed regarding exchange value. Money in an effective manner
eliminates the double presence of want by acting as a medium of exchange and is accepted
by every party irrespective of the desire of goods and services (Watson, 2018).

Money neutrality - The main aim of the money is to have neutrality in the economic
scenario. It is of the opinion that the authority of money should direct towards money
neutrality in the economy. Commercial alterations happen due to the presence of monetary
change (RBA, 2018).

Stability of exchange- Monetary authority mainly resides on the exchange stability, and
it needs to be noted that the instability in the rate of exchange can lead to significant issues
resulting in the adverse balance of payments. Hence, stable transfer plays a vital role
regarding international trade. A steady rate of exchange helps in maintaining international
trade. Therefore, it is evident that the equilibrium needs to be kept in the country so that
fluctuations or deviation does not happen.

It is the primary function of the Reserve Bank of Australia to ensure that the monetary, as
well as banking policy, should be directed in a fashion that will help in stabilizing the
currency of Australia, maintenance of full employment and the overall economic prosperity
(Mankiw et. al, 2011).
Further, the Reserve Bank strives to promote the total stability of the financial system that aims to reduce the
stake of the financial complexities that contains major effects and respond to the financial system
disturbances. The bank has to work on such disturbances in collaboration with other agencies (Mankiw et. al,
2011). Further, the Reserve bank design produces, as well as issue banknotes with the primary objective of
ensuring public confidence in notes that is considered as a significant payment scheme and ensures storage of
wealth. Moreover, it even provides banking services of specialized nature to the government, as well as foreign
official institutions. It contains payments, as well as collections and other forms of maintenance..

2. Money market equilibrium model: Transmission mechanism can be explained as

that procedure by which decisions based on monetary policy can play a vital role in
influencing the pricing level and economy on the whole. Further, transmission of monetary
policy can be explained as to how any variation in the rate of cash can influence the business
and household interest rates, inflation, and employment on the whole. Moreover, such
transmission can assist the Reserve Bank in evaluating all future and present economic
developments that also includes the establishment of effective monetary policies.
Nevertheless, a central bank can play a vital part in the determination of interest rates at
which the overall banking system attains resources.

This can affect the rate of deposits and lending together with variables like prices of assets
and exchange rates. Further, the decisions on the Monetary Policy Macroeconomics Case
Study also influence future inflation anticipations (Mankiw et. al, 2011). Overall, exchange
rates, a rate of interests, prices of assets, etc. can pursue a powerful impact on decisions
based on investment and saving, overall demand and supply, etc. Therefore, when the total
demand is lesser than the global supply, there will be a declining impact on the prices and
vice-versa. In general, such a transmission mechanism can be explained as a complicated
web of several financial transactions wherein it is problematic to quantify the impact of
decisions of monetary policy on the level of price and the overall economy. Nonetheless,
considering the loopholes in the process of transmission, any variations in the monetary
policy made today can affect the level of pricing after years or months.

The central banks must also be capable of ascertaining what policy stance is required in the
current phase to sustain the stagnancy of prices in the upcoming tenure. Moreover,
considering the complications prevalent in the process of transmission, there exists a
considerable element of unpredictability revolving around the size and timing of adjustment
exaggerated by variations in the approach of monetary policy (Dolamore, 2018).
Nevertheless, in this context, an orientation of medium-term is attractive in the scenario as
it can assist in safeguarding unnecessary and irrelevant volatility in the entire economy.
Nonetheless, when there is a lessening of cash rate by the Reserve Bank, other standards of
interest in the whole economy also decline. Besides, lesser rates of interest also encourage
spending. Further, businesses also react in such a situation by enhancing their production
so that it can result in an increment of overall employment and activity. Hence, if demand is
high, prices can be boosted, thereby resulting in more inflation.

3. Factors that form part of the altering cash rate of the RBA : The role of RBA
(Reserve Bank of Australia) is to make sure that the welfare and economic prosperity of
people are maintained, and monetary policy can serve as a significant tool in controlling
inflation and encourage factors like sustenance of overall Australian employment, stagnancy
of Australian currency, and welfare of the entire country on a whole (Dolamore, 2018).

Besides, considering the amount of money being rotated throughout the country, the RBA
may either hold, increase, or lessen the rate of cash based on basis points so that demand
can be increased or national spending can be restrained. Nevertheless, the factors taken into
due consideration in this regard is as follows:

About the Australian economy, the Reserve Bank may look at factors such as:

i. Consumer and business confidence- Lower consumer and business confidence can
enhance the possibility of a cut in rates so that demand can be increased. Besides,
less faith can transform into low growth and demand on a whole.
ii. Currency- The Reserve Bank can attempt to persuade the power of their money
through their official rate of cash. Thus, if their rate of money is higher when
compared to other countries, the dollar can be easily strengthened because all
investors demanding yield can invest their funds within the state. Moreover, an
almighty dollar is not good for the exporters while it is good for the importers.
iii. Household debt- Lesser rates of interest often endeavor in enhancing prices of
houses in the capital city areas. Therefore, when ‘bubble’ is used, it means there are
rises in prices of houses in the areas. Moreover, other factors like restrictions on
lending for basic tightening of lending needs can be beneficial in controlling the
entire housing industry (Watson, 2018).
iv. Inflation amounts- Higher the inflation, higher are the possibilities of increase in
rate because the Reserve Bank can attempt to curb customer demands. Moreover, it
also strives to maintain inflation of around two to three percent over the years.
v. . Employment- Higher chances of unemployment also enhances the possibilities of
cut in rates because the same can increase investment, business spending, etc.
b. Global economic situation: The Reserve Bank must consider the efficacies of the
overall international economy that includes how demand of consumers, international
housing markets, and currencies have been progressing. Further, it would also take into
consideration the power of countries like USA, China, and other European Countries for
better evaluation (Sexton & Fortura, 2005).

4. Cash Rate unchanged : The cash rate was left unchanged by the Governor of the RBA
for the last 28 months because an alteration in the interest rate affects interest on mortgage,
savings and the overall health of the economy. The cash rate can be defined as the interest
rate that the banks change every other on the overnight loans. Banks usually lend money to
other banks every day so that daily cash needs can be managed (Bendel, 2017). As the loans
are present for the shortest term it is defined as the overnight funds and the interest charged
is the overnight rate. Further, the cash rate is said to be the interest rate on the lowest term,
and this is considered as the benchmark rate.

The RBA kept the cash rate stagnant because it wanted to keep the demand growth in
flourish mode and the rate of inflation was seen at 1.9%. As the terms of trade in Australia
was in a promising manner and stronger than the earlier times, the national income
boosted. Further, commodity prices reduced and the costs of oil fell majorly. Hence, the
Australian dollar remained at a range over the past few years. The positive outlook of the
market further ensured that the cash rate remains unchanged. Instead of this, the governor
of the RBA decided to settle the price. As the economy was in a growing trend, therefore, it
was likely that the rate of unemployment will be low. Considering the factors, it can be
commented that the stronger labor market proved to be of significant benefit for the overall
development (Bendel, 2017). The enhancement in the economy was the primary reason that
the cash rate was left unchanged for the last 28 months. The cash rate is changed when the
demand tends to be uncertain, and improvement is missing in the economy.

Further, it needs to be noted that the cash rate influences the likelihood of the business and
household for the funding process. Overall, considering the position of the economy, it can
be commented that the link between the exchange rate, inflation, as well as the cash rate is
complicated. The cash rate is of pivotal importance when it comes to the consumer, as well
as businesses as the cash rate movement can influence lending, as well as borrowing
activities. Therefore, going by the position of the Australian economy, the inflation and
other relevant factors the cash rate was left changed by the governor of the RBA.

5. Economic growth : Economic growth can be defined as an enhancement in the ability

of an economy or country to produce goods and services when compared from one tenure to
another. Such economic growth can be easily measurable in real or nominal terms, the
former of which can be adjusted for inflation. Besides, it is also feasible to attain economic
growth in the absence of an increased aggregate marginal productivity through additional
higher rates of birth or immigration. Economic growth also has a ripple impact wherein by
diversifying the entire economy; businesses can witness an increase in profits that means
prices of stock rises as well (Mankiw & Taylor, 2011). Such companies can then raise funds
to invest more, thereby paving a path for adding further jobs to the entire workforce.

Long-run growth can be explained as the sustained increment in the overall quantity of
services and goods that is produced by an economy. The Gross Domestic Product (GDP) of
an economy is also closely interconnected with the growth of such population together with
supply, demand, and prices. The major determinants of long-term growth are as follows:

a. Demographic alterations: Demographic traits influence economic growth by

altering the ratio of employment to population. Further, factors such as quality and
quantity of prevalent natural resources are also included in this segment.
b. Productivity growth: This is the ratio of economic outputs to inputs such as
materials, energy, labour, capital, etc. Therefore, when there is an enhancement in
productivity, the cost of goods is diminished, Besides, lesser prices can enhance the
demand for such products and services, thereby assisting in attaining maximum
revenues (Braeutigam, 2010).
c. Participation or involvement of labour force: This is another determinant of
long-term growth wherein the amount of involvement of the labor force and the size
of all economic sectors can persuade economic growth. Further, the participation of
the labor force is the requisite number of available workers in the economy.
Moreover, about countries that have higher industrialization and development, such
involvement of the labor force is also higher owing to lesser death and birth rates.

Conventional wisdom has held that lower interest rates can allow entrepreneurs to be
motivated toward borrowing so that they can invest in new productive abilities, thereby
accelerating higher growth. Further, when lower interest rates of 1.50% have been prevalent
in an economy, it would make more sense for the capital owners to gear up and invest their
resources in existing assets like financial instruments or property instead of risking their
funds in unspecific new ventures. Nevertheless, even though the anticipated returns may
not be as appealing as desirable by the owners, but such leverage can motivate them, and
the pay-off is attracting as well (Braeutigam, 2010). Furthermore, based on the analysis of
various economists, lower interest rates can assist in reigniting the overall housing market
with investors surging back and capital gains increasing within the market. Such a lower
interest rate can also help in tackling the risks of rising indebtedness level. Overall, long-
term economic growth can be attained through such a lower interest rate.

Conclusion
From the overall discussion, it can be commented that the monetary policy of the country is
an essential step towards the stabilization of the economy. It is one such action by the
central bank that helps in macro-economic policy aims of low inflation and economic
growth in a sustainable manner. The overall discussion relates to action taken by the
Reserve bank of Australia in the financial market to attain the desired act of monetary
policy. As Australia contains lower stance of inflation with labor market positive thereby, it
is imperative that the monetary system was left unchanged.

References
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