Economics 2.2.4

monetary policy and Reserve Bank of Australia yr 10 2026

monetary policy

set of actions available to a nation's central bank to achieve sustainable economic growth by adjusting the money supply

role of RBA

responsible for monetary policy to keep inflation low and stable while fostering full employment and price stability

objectives of RBA 1

stability of the currency in Australia

stability of the currency

low and stable inflation which preserve the purhcasing power over time

objectives of RBA 2

maintenance of full employment in Australia

maintenance of full employment

related to the RBA promoting an environment that supports full employment

even at full employment

people may be unemployed due to skill unmatches or as they move between jobs

objectives of RBA 3

economic prosperity and welfare of people in Australia

economic prosperity and welfare of people

achieved by maintaining stable macroeconomic environment and means the Reserve Bank Board considers other factors when setting monetary policy

transmission mechanism of monetary policy

describes how changes made by the RBA to the cash rate flow through economic activity and inflation

transmission mechanism 1

changes to the cash rate through to other interest rates in the economy

changes to cash rate

while cash rate may act as a benchmark, it is not the only determinant

how spread/difference cause to change over time

other factors, like conditions in financial markets and risk associated with different loans, can impact interest rates

changes to cash rate example

increase in banks' lending rates relative to the cash rate since the financial crisis

transmission mechanism 2

changes to the interest rates affect economic activity and inflation through channels

changes to interest rates example

how reduction in interest rates affect aggregate demand and inflation (a tightening in monetary has the opposite effect on aggregate demand and inflation)

aggregate demand (related to transmission mechanism)

lower interest rates increase aggregate demand by stimulating spending, however this may take a while as equipment and workers are needed

when aggregate demand is initially greater than aggregate supply

it puts pressure on prices and as businesses increase their prices more rapidly to respond to demand, causing inflation

transmission channel 1

saving and investment channel

saving and investment

influence economic activity by changing incentives for saving and investment, affects consumption, housing and business investment

Consumption and Investment 1

lower deposit rates decrease saving incentives and encourage household spending, as lower lending rates boost borrowing and reduce repayments, thus increasing demand for housing assets and investment spending by businesses

transmission channel 2

cash-flow channel

cash-flow 1

interest rates influence decisions of households and businesses by changing amount of cash they can spend on goods and services

cash-flow 2

important for those who are liquidity constrained (those who cannot spend or borrow as much as they want because of interest repayments or current interest rates)

cash-flow 3

lower lending rates reduce interest repayments on debt, increasing amount of cash available for households and businesses to spend

cash-flow 3 example

lower lending rates reduce variable-rate mortgage repayments, increasing disposable income for households, however, it reduces interest earned on deposits and some may choose to restrict their spending, however the first option is more likely than the second

transmission channel 3

asset price and wealth channel

asset price and wealth

how much they can spend and borrow in the economy

asset price and wealth lower lending rates

support asset prices by encouraging demand and increasing future income value, increasing equity of an asset for banks to lend and households and businesses to borrow, promoting spening as people utilise their increased wealth