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MONETARY POLICY (Transmission mechanism / Channels of monetary policy…
MONETARY POLICY
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Purpose
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maintain full employment
Full employment:
- the absence of cyclical employment; but acknowledges the presence of structural and frictional unemployment as part of a functioning economy;
- NAIRU = 5-6%
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Stances
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looser / expansionary => CR \\
to stimulate econ activities,
raise employment prospects (unemployment \\ )
tight / contractionary => CR //
to slow econ activities,
reduce inflation and inflationary expectations
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Monetary policy refers to actions by the RBA to influence the supply and cost of credit (money) in the economy.
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a swing instrument / counter cyclical policy / pre-emptive=>
enacted to avoid excessive inflation in booms or rising unemployment in recession
cash rate => principle instrument; the interest rate paid on funds lent overnight in the cash market; determined by S(RBA) + D(banks' ESA reserves) for funds/cash
Announcement effect:
RBA announces its intention to alter the CR target before implementing any change in the stance of monetary policy in the cash market.
This sends a clear signal (transparency) to financial markets and economic agents of the change in the stance of monetary policy, and this influences price and wage expectations in the future.
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CR //: RBA purchases CGS or Repos from institutions in the cash market and inject cash in return; RBA increases supply of cash #
counterparties incl. banks, investment houses, pensions, superannuation funds (members of Reserve Bank Information Transfer System) #
Liquidity management operations: ensure that there is the correct amount g cah in surplus ESA to meet the demand for funds in deficit ESA #
Real Gross Time Settlement (RGTS): the ability og RBA to settle payments immediately to maintain the cash rate #
Changes in the official cash rate then flow through to other interest rates in the money market, eg. those on business lending, housing mortgage rates and credit card rates. Changes in interest rates at the short end of the yield curve are affected by changes in the cash rate and those at the long end of the yield curve (bond rates) are more influenced by inflationary expectations. (p. 313)
Changes in the CR will impact initially on short term interest rates, then on medium to long term IR, and ultimately alter the cost of borrowing and the returns for lending funds.