Chapter 11 - Monetary Policy

monetary policy

• macroeconomic policy that involves action by RBA, on behalf of gov to influence the cost and availability of money and credit in the economy

• conducted by RBA

RBA 3 objectives when setting M.P

1) stability of currency

2) maintainence of full employment

3) economic prosperity and welfare

when will RBA implement contractionary M.P?

• when inflation is exceeding target

what happens when inflation exceed target?

1) consumer purchasing power falls

• price rising faster than their income

2) internatiinal competitiveness falls

• worker wage expectation may increase, thus business COP increase, leading to cost push inflation

3) real value on return on investment falls

• although ‘number’ same, return on investment can buy less things due to inflation

when will RBA implement expansionary MP?

• when inflation lower than target

what happens when inflation lower than target?

1) consumer delay purchases when they expect price to fall

2) downward pressure on price

• consumers spend less and business receive less revenue, thus reduce wages

• usually, businesses will let wages follow trend of inflation but if inflation already too low, they cant reduce wages anymore, so they lay off workers

conventional MP

• action by RBA to influence cash rate through DMO process

cash rate

• interest rate set by RBA that banks pay or charge to borrow funds from other banks in overnight market

DMO(domestic market operation) process

• when RBA buy/sell bonds to financial insituitions to inject/withdraw cash from financial systems to influence cash rate

contractionary DMO

expansionary DMO

unconventional monetary policy

using tools that dont change interest rate to influence economy

unconventional monetary policy types

• forward guidance

• asset purchase

• term funding facilities

• adjustment to market operations

• negative interest rate

forward guidance

• central bank communicate stance of MP

• time based guidance - bank commit to certain MP stance until specific time

• stance based guidance - bank commit to a certain MP stance until specific economic condition met

asset purchase

• outright purchase of assets by central bank from private sector

• injects money into economy, encourage lending and investment

term funding facilities

• allow bank to borrow from RBA at lower cost IF bank lower lower IR for borrowers too

adjustment to market operations

• provide larger amounts of liquidity to financial system(give banks money)

• expand range of accepted collateral

• increase range of eligible counterparties they allow to engage in DMO

negative interest rate

• people get charged to deposit money into bank