Lesson 1 - Monetary Policy

AS 2.6 Overview

AS 2.6 (91227) - 6 credits focuses on analyzing how government policies and contemporary economic issues interact.

Government policies are decisions by the Government that aim to influence economic activity within the economy.
Policy Objectives: Goals that the Government seeks to achieve through its policies (e.g., increasing spending as a policy to reduce unemployment).

There are four main types of government policies:
- Monetary Policy
- Fiscal Policy
- Regulation/Deregulation Policy
- Free Trade and Protection Policy

Common objectives of government policies related to economic issues include:
- Inflation Control: Maintaining price stability.
- International Trade: Increasing export receipts.
- Economic Growth: Elevating New Zealand's growth rate.
- Unemployment: Reducing unemployment levels.

To achieve:
- Define, identify, and describe government policies.
- Draw relevant economic models illustrating government policies.
- Identify causes and effects of changes within these models.
- Explain the flow-on effects of a policy on other economic issues.

In addition to 'Achieved' criteria:
- Elaborate on definitions and descriptions of government policies with context and examples.
- Explain causes and effects of model changes with reference to graphs.
- Discuss two flow-on effects of a policy on other economic issues.

Beyond 'Merit' evidence:
- Justify the combination of government policies that achieve specific policy objectives related to contemporary economic issues and minimize any negative flow-on effects on other issues.

Key Concepts:
- Definition: Use of the Official Cash Rate (OCR) to control inflation and manage the money supply/credit.
- Responsible Entity: The Reserve Bank of New Zealand operates monetary policy.
- Goal: Maintain an average inflation rate between 1 and 3 percent, focusing on a 2 percent target as per the Policy Targets Agreement (PTA).

Function:
- The OCR is the interest rate at which trading banks borrow from the Reserve Bank.
- Higher OCR leads to higher interest rates in the economy; lower OCR encourages borrowing and spending.
- Reviewed eight times a year, affects banks' interest rates and overall economic activity.

Contractionary Monetary Policy:
- Used when inflation exceeds the target range; leads to an increase in OCR, resulting in increased interest rates.
- Impacts:
  - Consumer Spending: Reduced as higher interest rates make borrowing less attractive.
  - Investment Spending: Firms may reduce new investment due to higher borrowing costs.
  - Economic Growth: Slows down due to lower demand from consumers and businesses.
  - Unemployment: Rises as firms cut back on production.
Expansionary Monetary Policy:
- When inflation is below the target, the OCR is lowered to stimulate economic growth.
- Increases in consumer spending and investment may occur, promoting economic growth and potentially reducing unemployment.

Higher Interest Rates: Attract overseas savings, which increases demand for the New Zealand dollar, leading to an appreciation of the currency.
Effects on trade include:
- Higher consumption of imports due to lower cost.
- Reduced competitiveness of exports due to higher prices.

Contractionary Monetary Policy:
- Inflation decreases.
- Economic growth decreases.
- Unemployment increases.
- Net trade performance (X-M) decreases.
Expansionary Monetary Policy:
- Inflation can either increase or decrease.
- Economic growth generally increases.
- Unemployment can decrease as businesses expand.
- Net trade may show an increase or decrease depending on various factors.

Understanding the interaction between government policies and contemporary economic issues requires analyzing the effects on inflation, growth, unemployment, and trade using economic models and contextual examples.