Monetary policy

Conventional Monetary policy

A macroeconomic policy operated by the Reserve Bank of Australia (RBA) that involves changes in the official cash rate to influence the cost, availability, and demand for credit in the economy, in order to achieve its economic objectives.

cash rate

The interest rate on overnight loans between financial institutions in the short-term money market, which is set by the RBA through its market operations.

interest rates

The cost of borrowing money or the return on savings, usually expressed as a percentage. The RBA influences short-term interest rates through changes in the cash rate.

Transmission mechanism of monetary policy

The process through which changes in the cash rate affect economic activity and the rate of inflation. The main channels include the cost of credit, cash flow, availability of money and credit, asset prices, and exchange rate effects.

Expansionary monetary policy

A stance of monetary policy where the RBA sets the cash rate at a low level to stimulate aggregate demand and economic activity, typically during periods of low inflation or weak growth.

Contractionary monetary policy

A stance of monetary policy where the RBA increases the cash rate to reduce inflationary pressure by dampening aggregate demand.

Neutral stance of monetary policy

A setting of the cash rate that is neither expansionary nor contractionary; it is consistent with achieving the RBA’s economic objectives without stimulating or dampening growth.

Inflation targeting

The framework under which the RBA sets monetary policy to achieve an inflation rate of 2–3 per cent, on average, over time.

Open market operations (OMO)

The buying and selling of government securities by the RBA in the short-term money market to influence the cash rate.

Short-term/Overnight money market

The financial market in which funds are borrowed and lent for short periods (usually overnight), and where the RBA implements monetary policy through open market operations.

Domestic economic stability

A situation where the economy achieves low inflation, full employment, and strong and sustainable economic growth, consistent with the RBA’s objectives.

Aggregate demand

The total expenditure on an economy’s goods and services at a given price level and time period, comprising consumption, investment, government spending, and net exports (C + I + G + (X – M)).

Saving and investment channel

This channel typically affects consumption, housing investment and business investment.

Cash flow channel

A channel where changes in interest rates affect disposable income for borrowers and savers, influencing their spending behavior.

Price stability

The achievement of sustainable low and stable inflation (2-3%)

Asset prices channel

A channel where interest rate changes influence asset prices (e.g. housing, shares), affecting household wealth and confidence.

Exchange rate channel

A channel where interest rate changes affect capital inflows/outflows and the exchange rate, thereby impacting net exports and aggregate demand.

Forward guidance

a monetary policy tool where central banks communicate their intentions about future interest rate policy to influence market expectations and behavior

unconventional monetary policy

central bank actions that go beyond traditional tools like adjusting interest rates. These policies are typically used when standard measures are insufficient, such as during economic crises or when interest rates are already near zero. Examples include quantitative easing, forward guidance, and negative interest rates