Objectives of Monetary Policy
The present study is focused on the description and evaluation of impact, effectiveness and mechanics of monetary policy decisions made by Reserve Bank of Australia. Study include a description of functions and objectives of RBA and monetary policies. Further, it explains circumstances in which increase and decrease can be made in cash rates along with its impact on housing market participants. In the last part of the study, comparative evaluation of conventional policy and discretionary inflation targeting will be done.
The monetary strategy is chosen by the government in the aspect of determining growth and development in a nation’s money supply. This policy is applied to deal with liquidity to generate economic expansion. Controlling a country’s money supply refers to liquidity which contains loans, cash credit (Bradley and Chen, 2015). The government of Australia has implemented monitory policy so as to attain macroeconomic objectives like expenditure, increase in prices, development and liquidity. The reserve bank of Australia has been set up objectives so as to attain price stability by determining inflation. There are several objectives imposed by governments which are enumerated below:
- Control over inflation: Monetary policy played an important role in controlling over increasing prices. These policies are imposed so as to control increase in demand, increase in rates of interest, decreasing the real money supply.
- Maintenance of full-employment: Main purpose of Reserve bank board for setting these objectives is to decrease unemployment so that each and every person who desires to work has the right to locate employment (Smales, 2013).
- Welfare of the country: Reserve bank board governs monetary policy in order to achieve economic success in Australia. Proper management in monetary policy will lead to the welfare of the nation and helps in growth and development in an economy.
The reserve bank of Australia is established by the central bank of Australia. It is permitted by the Act of reserve bank 1959. The objectives of the National economic policy are followed by the bank. The functions of the reserve bank contain implementation and formulation of the monetary policy, which promotes the financial stability. The reserve bank is working for promoting the overall permanence of the financial statement (Chen, Cheng, & Wang, 2015). Looking at the risk of financial disturbance which is having the systematic cost, they take action for the prevention disturbance in the financial system when it occurs. The CFR is managed by the director of the reserve bank. The bank contributes in managing and regulating the effectiveness and efficiency of the financial system.
The Australia’s banknotes are produced, designed and issued by the Reserve Bank, with a vital objective of ensuring the self-assurance for the public as a store of secured wealth and useful payment mechanism. The specific banking services are provided by the reserve bank to the official institution of foreign and government. Services provided to them which include collection and payment and also reporting and maintain the general account (Pagan & Wilcox, 2016). The system of the high-value payments is also operated by the reserve bank. In addition to this, the reserve of foreign currency of Australia is managed and holds by the reserve bank. Further, the foreign exchange market is operated on the regular basis for meeting the needs of foreign exchange of their clients and supports them with the management of domestic liquidity.
Functions of Reserve Bank of Australia
The main objective of Reserve Board of Australia is to help the government of Australia and other financial institution in providing banking services. It is the sole authority for issuing bank note. The cash rate is the interest rate which is charged by the Reserve Bank of Australia from central banks of other country and financial institution in Australia for overnight loans (Kramer, 2014). The term inflation is the situation where the general prices of the commodity and services are increases. Almost Every month RBA meeting are organised to discuss cash rate.
The reserved board of Australia control inflation or stimulate the economy by controlling inflation by rising up the cash rate so people would stop their self from financial consumption which leads to decrease in demand thus stopping the further increase in price. On the other hand, RBA lowers down the cash rate then people are able to obtain loans which lead to increase in demands thus encouraging an increase in price (Liu, and et.al. 2014). RBA for maintaining growth in the country’s economy and stability of price uses cash rate and to maintain the worth of money and works toward strong and long lasting growth it is important to control inflation. There is a complex relationship between the cash rate and inflation because cash rate affects consumer and business directly. If RBA down the cash rate than the spending of individual will increase. Cash rate also effects on the mortgage loan and house loan.
There are following circumstances in which the Board might increase and decrease the cash rate:-
In a situation where Reserve Board of Australia wants to stop the increase in demand and rate of inflation, then they change their cash rate. The increase in cash rate will have a negative impact on demand and inflation when RBA wants to increase in the disposal income of the persons then they lower down the cash rate (Costello, Fraser & MacDonald, 2015). In a situation where there will be an increase in the cash rate, there will simultaneous increase in interest rate on deposit, with this approach they will be able to motivate people for investment instead of expenditure, as they can earn a good return. This strategy will provide stability to market which will ultimately result in controlling inflation.
Further, when Reserve Board of Australia wants to take control on the import and export of country, they change the cash rates which will results Exports become cheaper, and import becomes costly if the value of the AUD (Australian dollar) falls against other currencies. It is generally good for the economy, but it leads to raising inflation (Palley, 2013). Well reserve board of Australia take into consideration that if the interest rate is going down in another country then foreign investor will look towards other countries in expecting better result, which will reduce foreign direct investment flow in the Australia which leads to slow down the growth of the country so for attracting foreign investors, to invest in the country RBA change their interest rate.
Transmission Mechanism of Cash Rate Change
Main factors that restraint Reserve Board of Australia from changing cash rate significance for the Australia to see what countries are doing with their consumer demand, housing market and currencies. For this aspect, RBA had considered the international economic condition that how the United States, China and other large economy are performing (Galí, 2015). By paying attention to a Domestic economic condition which is equally vital for reserve board of Australia for considering the changes in the cash rate. In domestic condition, RBA had a look for employment, inflation, household dept., currency valuation, and business and consumer confidence. Due to high unemployment in the country, RBA would cut the rate of interest which will lead to increase in spending. As a result boosting the employment (Neely, 2015). RBA wants inflation rate to be 2-3% on average, due to which rate is not altered as present inflation in the economy is at a viable rate. RBA also acknowledge the business and consumer takes decision according to the situation in the country (Chronopoulos, McMillan & Wilson, 2015). Other factors which have been considered by RBA is stability in the financial market, and at last, they had seen the effect of cash rate on local banking channel.
Figure 1: Snapshot of Australian economy
In accordance with the media release by RBA, economic growth of country was 2.4% while inflation was 2.1%. Further, for the maintenance of stability in financial stability cash rate was not modified by RBA. Further, the release indicates that average weekly earnings of the country were $1164 and the household saving ratio was 5.8% (Mohan & Kapur, 2014). In all three sectors, service sector of the country had outperformed by providing a contribution of 59% in the GDP. Media release shows that there were no substantial surprises, however, more upbeat on growth in 2018 in comparison to Westpac (Galí, 2015).
So as you see RBA remain unchanged the cash rate at a low of 1.5%. experts are predicting that inflation will go up and economic growth will likely to increase by 3% in a couple of year. An average interst rate of australia is 4.74%from 1990 to 2017. Interest rate recorded all time high in jan 1990 of 17%. RBA remain unchange the cash rate because despite of fact that unemployment rate increases but the present employmnt growth has noted a little stronger. Labour market indicator are remain mixed. It is seen that decreases in the interest rate help the economy following mining investment boom. If there is any change in the interest rate was happen, than it will result in complex growth.
Factors Influencing RBA’s Decisions
The term cash rate means the overnight loan given by Reserve Board of Australia to the central bank of other countries and financial institution of Australia. For maintaining sustainable growth, RBA revises its cash rate policies which affect lender’s fortune and stability in the economy (Yates, 2014). The main objective for easiness in cash rate is to boost employment, the basic concept behind lenient in the interest rate is to individual build more which provide employment to employed. And it will also help in pushing the price of property up. Whenever RBA decides to revise its cash policies, it kept in mind the housing market.
Changes in Cash rate policies directly affect the house market participant because it decides the interest rate on which businesses take loans (Brown & Davis, 2015). If reserve board of Australia decreases the cash rate, then the bank will able to lend more loan and give back to market at reasonable rate. As a result, housing market participant will able to invest more because repayment is smaller, and if RBA decides to increase the cash rate, then bank try to put brakes on their lending, which will reduce the money flow in the market. As a result, obtaining loans attract more interest rate for housing market participant, and housing market participant cannot spend their money freely.
To save the housing market from financial crisis, RBA should be considered about rapid increasing in property price and borrowing of investors because it will lead to inflation in the country. RBA targeted that the inflation cannot go beyond 2-3 % on average. Inflation is a situation where prices of the good and services were significantly increasing. Australian Bureau of Statistics says that there is an increase in the lending with 27.5% in the last year (Jain, Keneley & Thomson, 2014). One major reason for concern is housing affordability for all. Due to continue rising in price, the young individual thinks to take out their saving and invest it in property which will lead to creating financial risk. Global financial crisis of 2008 alert RBA to make policies towards investors borrowing. In GFC mortgage approval rates are high, and it leads to a large number of the home buyer which rises the housing prices.
Macroprudential Policy Frameworks issued by RBA shows that governor has clear objective stricken lending standards due to increased risk in the environment. Further, the concern about the policy provided stability to a financial system which was at risk. Suggested policy in this framework will satisfy the dual task of managing inflation along with stability in the financial system.
Impact of Changing Cash Rate on Housing Market
Figure 2: Macroprudential Policy Frameworks issued by RBA
The major disadvantage of conventional monetary policy is that it doesn’t guarantee recovery of the economy because, during recessions, not every consumer would have the self-assurance to pay out and take benefit of low-interest rates. This policy is not helpful in global recessions, as export sectors will bear losses in case banks would decrease interest rates. It also doesn’t assure to cut off the interest rates. However monetary policy let banks to get benefits from lower interest rates as they take a loan from central banks, but some of them might have the loans. As a result, it will lead to the short supply of funds and people will not able to borrow funds for a long duration. It takes the time to get implemented in the economy (Robinson, Tsiaplias & Nguyen, 2016). According to economists, it takes years to change a policy and implement it. Due to this factor, it also de-motivates companies to grow and develop. By this policy, production will decrease, and prices will increase as businesses will not extend their operations, due to increase in interest rates. Deflation is another drawback of traditional monetary policy it may intensify recessions due to the increase in real value.
Monetary policy is better policy option rather than discretionary inflation targeting. In accordance with the study of Jain, Keneley & Thomson (2014) in monetary policy banks lower the rates of interests so that business can expand their operations as they will be provided loans at a low interest rate. As result prices of goods well decrease and demand will increase. Study of Trott (2015) shows that one of the major advantages of monetary policy is that it stabilises and lowers inflation rates. Due to this factor monetary policy is proven better option as it is more reliable and flexible than inflation targeting to attain mid-term stabilisation goals.
Discretionary inflation targeting is dangerous for a nation for a long term as it discourages several industries and leads to a high monetary deficit. According to the viewpoint of McCallum (2015), it can also be an issue to dynamic inconsistency: as then government increases interest rates to stabilise inflation. Consequently, it will slow down its position afterwards. As a result, this will make policy less reliable and useless. No scope for domestic policy as it will result in financial consistency problems. It gives too much attention to inflation rather than concentrating on other goals. It decreases flexibility in the economy and also overlooks money. It works as a structure not as a law for monetary policy because if IT would be implemented as a policy rule, then it will result in poor and low monetary returns. It also limits the ability of central bank in responding to a financial crisis or external shocks or unforeseen events. A possible poor return in case of employment and it also lacks public support.
Limitations of Conventional Monetary Policy
Conclusion
In accordance with the present study, conclusion can be drawn that RBA plays a significant role in macroeconomics of Australia. They aim to provide stability to the Australian economy by developing effective monetary and fiscal policies as per the circumstances in the market. Same has been reflected in the media report released by RBA which shows that, economic growth of country was 2.4% while inflation was 2.1%. Further, for the maintenance of stability in financial stability cash rate was not modified by RBA.
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