monetary policy

What is the cash rate?

The interest rate that banks pay to borrow funds from other banks overnight on short

Who sets the cash rate target in Australia?

Reserve Bank of Australia (RBA).

What is Open Market Operations (OMO)?

The buying and selling of government securities by the RBA to influence the supply of cash and maintain the target cash rate.

What are the objectives of monetary policy?

1. Price stability (2–3% inflation over the medium term) 2. Full employment 3. Economic prosperity and welfare.

What are the three main monetary policy stances?

Expansionary (lower rates), contractionary (higher rates), and neutral.

What is the role of the RBA in monetary policy?

The RBA sets the target cash rate and uses open market operations to achieve it, aiming to influence the cost and availability of credit.

What is meant by easing monetary policy?

Lowering the cash rate to stimulate economic activity and increase aggregate demand.

What is meant by tightening monetary policy?

Raising the cash rate to slow economic activity and control inflation.

What is the transmission mechanism?

The process through which changes in the cash rate influence economic activity, particularly aggregate demand (AD), output, and inflation.

What are the four main transmission channels of monetary policy?

1. Savings and investment 2. Cash flow 3. Asset prices and wealth 4. Exchange rate.

How does the savings and investment channel work?

Lower rates reduce borrowing costs, encouraging spending and investment. Higher rates encourage saving and reduce investment.

How does the cash flow channel work?

Lower rates reduce loan repayments, increasing disposable income and business cash flow. Higher rates increase repayments, reducing spending.

How does the asset price and wealth channel work?

Lower rates increase demand for assets (e.g., housing, shares), raising wealth and confidence. Higher rates reduce asset demand, lowering wealth effects.

How does the exchange rate channel work?

Lower rates cause capital outflows and a weaker AUD, boosting net exports. Higher rates cause inflows and a stronger AUD, reducing net exports.

Why are the transmission channels considered indirect?

Because the RBA does not control spending directly — it influences market conditions that affect household and business decisions.

What is the impact of expansionary monetary policy on aggregate demand?

Increases AD by lowering borrowing costs, boosting consumption, investment, and net exports.

What is the impact of contractionary monetary policy on aggregate demand?

Decreases AD by increasing borrowing costs, reducing consumption, investment, and net exports.

How can monetary policy influence inflation?

Lower rates increase demand and can push inflation up. Higher rates reduce demand and can bring inflation down.

How does monetary policy affect employment?

Expansionary policy increases demand for labour, lowering unemployment. Contractionary policy may reduce demand and increase unemployment.

What is the time lag issue in monetary policy?

It takes months or years for policy changes to fully affect output, inflation, and employment — making precise timing difficult.

What are some limitations of monetary policy?

Indirect impact, long time lags, external shocks, and competing objectives (e.g., inflation vs unemployment).

Why may lower interest rates not always stimulate the economy?

If consumer confidence is low, people may save instead of spend. Banks may also not fully pass on rate cuts.

How can global factors affect the effectiveness of monetary policy?

Exchange rate fluctuations, capital flows, and international interest rate trends can offset domestic policy actions.

What is the role of expectations in monetary policy?

Inflationary expectations influence wage bargaining and investment decisions, affecting how policy impacts the economy.