Monetary Policy

1. Monetary Policy Its impact upon our objectives.

2. Monetary Policy Definition • Monetary policy is predominantly the changing of interest rates to effect AD. • A decrease in interest rates is known as expansionary monetary policy. • An increase in interest rates is known as contractionary monetary policy

3. The RBA • It is the responsibility of the RBA (not the government) to manipulate interest rates. • This allows the manipulation of interest rates to occur without and political motivation (ie fear of being voted out at the next election) • Another role of the RBA is prudential supervision, that means it over sees all banks to ensure they are acting responsibly • COPY FIGURE 6.1 pg 206 into your books

4. OPEN MARKET OPERATIONS • To increase or decrease interest rates the RBA can set the cash rate. • The cash rate is the official interest rate that applies to a specialised market called the overnight or short term money market.

5. Transmission channels • Interest rates effect the level of economic activity through transmission channels. This means they effect peoples decisions to either: • -Save • - Invest (purchase property etc) • -Spend • - The supply of credit (eg taking out loans from banks, using credit cards) • -Asset prices • -The exchange rate

6. Expansionary Monetary Policy • When interest rates are lowered or at already very low levels this is known as expansionary monetary policy • Expansionary Monetary Policy is aimed at increasing AD. People are encouraged to take out loans and increase investment expenditure on such things as houses or expand their businesses.

7. Expansionary Monetary Policy and its impact on Growth and Employment • When people increase investment expenditure AD increases and jobs are created. This leads to increased employment opportunities which contributes to increased Economic growth. • Businesses may be more willing to take out loand and expand, thus needing more employees.

8. Expansionary Monetary Policy and its impact on Price Stability • People tend to save less, and spend more as credit becomes more easily available (the transmission channels mentioned previously) • If spending and demand increases to such an extent that it outstrips supply then this will cause inflation

9. Expansionary Monetary Policy and its impact on External Stability • Low interest rates impact upon external stability in different ways. • When interest rates are lower in Australia than in other countries, FOREX investors may chose to put their currency in other countries banks. • This will have the effect of lowering our exchange rate.

10. If our exchange rate depreciates this will increase the cost of imports for Australians thus improving our CAD situation. (ie we purchase less imports) • Also with a lowered exchange rate our exports become more attractive thus encouraging expenditure on (X) which increases AD and also reduces our CAD.

11. A “Dirty Float” • A “dirty float” is when the RBA intervenes in the FOREX market to purchase or sell AUD (Australian dollars) thus manipulating its value • This is a small part of monetary policy that rarely occurs. • If the RBA wants to increase the value of our dollar it will purchase Australian Dollars, thus artificially increasing demand for our currency and hence increasing its value.

12. If the RBA wants to deflate the value of the dollar (to help exporters) , it will sell AUD on the FOREX market, thus artificially increasing supply and causing a the dollar to depreciate. • The “dirty float” rarely works in the long term and hence is not used very often.

13. Monetary Policy and its impact on Equity in Personal Income Distribution • When interest rates are low, more people have access to credit, which should mean more people have the opportunity to increase their purchases eg buy investment properties, thus increasing their income. • Also if more jobs are created, less people will rely on welfare benefits and actually have a job, hence lessening the gap between high income earners and low income earners.

14. Contractionary Monetary Policy • Contractionary monetary policy is when interest rates are increased. • This will have the opposite effect, as people are discouraged from taking our loans when interest rates are high. • Also people with existing loans now have to make increased payments to pay back their loan. • This will leave them with less disposable income to spend in the economy. This will contract AD, which should lead to lowered inflation. It will also decrease growth

15. Contractionary Monetary Policy and the exchange rate The exchange rate may be effected when Interest rates are increased, as FOREX investors may be attracted to invest in the Australian currency when our rate of interest is higher than that offered by other countries currencies. • Currently the Australian Dollar (AUD) is very high against the US dollar. This is in part due to the fact that our interest rates are much higher than that in the US.

16. Contractionary Monetary Policy and its impact upon Income Distribution • When interest rates are high, people tend to spend less which may see an increase in the unemployment rate. • When the unemployment rate increases the gap between high income earners and low income earners is widened (because more people rely on welfare), thus worsening equity in the distribution of income and wealth.

17. Interest rates and its impact upon resource distribution Interest rates also impact upon how efficienctly resources are allocated (land, labour, capital and management). This is because interest rates effect our decisions about where to spend and how much to spend or save.