Monetary Policy Basics
This Australian institution is responsible for implementing monetary policy
What is the Reserve Bank of Australia (RBA)?
This RBA objective aims to maintain low and stable inflation
What is price stability?
In the AE model, macroeconomic equilibrium occurs when aggregate expenditure equals this.
What is real GDP/output?
This is the process through which changes in the cash rate affect economic activity and inflation.
What is the monetary policy transmission mechanism?
This type of monetary policy involves changing the cash rate target.
What is conventional monetary policy?
This is the interest rate on unsecured overnight loans between banks in the overnight money market.
What is the cash rate?
This is the RBA's current numerical target for consumer price inflation.
What is 2–3% inflation?
A reduction in the cash rate increases consumption and investment. State the resulting change to the AE curve.
What is an upward shift of the AE curve?
A cash-rate increase raises variable mortgage repayments, leaving indebted households with less money available for other expenditure. Identify the transmission channel.
What is the cash-flow channel?
This situation occurs when interest rates are at or very close to zero, significantly limiting the RBA's ability to provide further stimulus through conventional cash-rate reductions.
What is the zero lower bound (ZLB)?
This type of monetary policy involves changing the cash rate to influence economic activity
What is conventional monetary policy?
Name the three broad objectives of monetary policy in Australia.
What are price stability, full employment, and the economic prosperity and welfare of the Australian people?
Expansionary monetary policy shifts AE upward. At the original level of GDP, what happens to firms' inventories?
What is an unplanned decrease/depletion in inventories because AE exceeds current output?
The RBA reduces the cash rate. Explain the likely effect on household saving and consumption through the savings channel.
What is lower deposit interest rates reduce the reward from saving, encouraging greater current consumption and therefore increasing AD?
This unconventional policy involves the RBA purchasing large quantities of government bonds in the secondary market.
What is quantitative easing (QE)?
The RBA lowers the cash rate from 4.10% to 3.85%. Identify the monetary policy stance and its intended effect on economic activity.
What is expansionary monetary policy, intended to increase AD, real GDP and employment?
Inflation is 4.5%, unemployment is below the NAIRU and the economy has a positive output gap. Identify the monetary policy stance the RBA would most likely adopt and explain why.
What is contractionary monetary policy, because higher interest rates can reduce AD and demand-pull inflationary pressure?
Trace the exchange-rate channel following an increase in the cash rate.
What is csh rate ↑ → Australian interest rates become relatively more attractive → demand for AUD ↑ → AUD appreciates → exports become less internationally competitive and imports more competitive → net exports ↓ → AD ↓?
Explain why the cash rate is important even though most households and firms do not borrow directly at the cash rate.
What is because the cash rate acts as a benchmark and influences other interest rates throughout the economy, including lending and deposit rates?
Real GDP grwth is weak, unemployment is rising and inflation is within the 2–3% target this explains why these conditions could justify a change in the monetary policy stance.
What is a shift towards expansionary monetary policy because the RBA could reduce the cash rate to stimulate AD, real GDP and employment without creating excessive inflationary pressure?
Trace the transmission mechanism from a cash-rate increase through to demand-pull inflationary pressure.
What is cash rate ↑ → market interest rates ↑ → borrowing becomes more expensive and saving more attractive → C and I ↓ → AD ↓ → real GDP growth slows and demand-pull inflationary pressure ↓?