Please enable JavaScript.
Coggle requires JavaScript to display documents.
Unit 4 AOS1 Economics (Government Policy) - Coggle Diagram
Unit 4 AOS1 Economics (Government Policy)
Monetary Policy maintains the stability of the financial system and issues the nation's currency
ROLE of the RBA charter sets out 3 goals:
stability of the currency
full employment
economic prosperity & welfare (SSEG)
Conventional monetary policy
Cash rate targeting - target the rate commercial banks borrow and lend to each other at in the STMM. In theory banks then pass these costs on to their consumers (increase/decrease in interest rates) to households and businesses
Exchange settlement accounts: accounts bank hold with the RBA used to settle transactions. ES accounts must be positive at the end of the day so therefore banks borrow and lend to each other to settle accounts
RBA intervenes by setting a floor and a ceiling (no transactions below or above) on the cash rate in this market
floor (deposit rate) = RBA will pay banks who have surplus in their ES accounts (deposit rate = CRT - 0.10%)
ceiling (lending rate) = rate the RBA will charge banks who have a deficit in their ES accounts (lending rate = CRT + 0.25%)
commercial banks would not lend to other banks at rate less than they could receive from the BRA (deposit rate) or borrow from other banks at a rate above what the RBA is charging (lending rate) = creating the interest rate corridor
Note for SSTM diagram:
supply curve is perfectly inelastic
equillibrium price is market cash rate for borrowing/lending
cash rate target is quoted rate by RBA
actual rate is where d/s intersect
Changing the cash rate target = done by simply moving its policy interest rate corridor up or down depending on interest rates
Unconventional monetary policy
used by RBA in conjunction with conventional MP to help achieve goals, used mostly in extreme situations. (asset purchasing - quantitive easing/tightening, forward guidance, yield targeting
Forward guidance = involves the RBA providing info about the future course of interest rates and its MP setting. Time based: time in which IR increase/decrease or State based: will not alter until particular condition
STANCE of monetary policy
CONTRACTIONARY: decrease AD = slowdown economy (tightening) (higher cash rate)
EXPANSIONARY: increase in AD = speedup the economy (loosening) (lower cash rate)
NEUTRALITY: when policy interest rate is low enough, it stimulates demand. and when its high enough, it restrains demand. in the middle is neither expansionary or contractionary and IR at this level with neither encourage nor disc
above 3.5% = contractionary
below 3.5% = expansionary
move closer to neutral = 'less'
move away from neutral = 'more'
Transmission mechanism of MP (channels MP affects AD)
SAVINGS & INVESTMENT
'cost of credit'
reward for saving and cost of borrowing
impacts decisions to save or borrow/spend/invest
affects both households and businesses through C + I components
EXAMPLE: an increase in interest rates: increase reward for saving and increase cost of borrowing. Leads to an increase in saving and decrease in borrowing, decreasing C and I components and decreasing AD overall
CASH FLOW
affects households and businesses who have existing debt - most households have variable interest rates - if RBA changes IR, interest repayments change - affects households discretionary income and business cash flow (C+I)
higher cash rates = increase in interest repayments on existing variable loans , less discretionary income for households and decrease in cash flow for businesses. Decrease consumption and investment spending and AD, lowering inflation
WEALTH/ASSET PRICES
interest rates increase/decreasse price of assets - low IR increase availability of credit, this increases demand for assets = increases price of assets - 'wealth effect' = if asset prices rise, ppl may feel like they have a higher degree of wealth and likely leads to an increase in spending.
Increase in IR's = decrease borrowing (availability of credit), decreased demand for assets, decreased price of assets, leads to a decrease in the 'wealth effect', people will decrease C and I
EXCHANGE RATES
'relative interest rates'
determine where investors will 'invest' their money, they find the country with the highest relative interest
this will change demand for AUD (and supply), the exchange rate and therefore X and M
increase in relative rates of return for overseas investors will decrease demand for AUD, or increase supply for AUD leading to an depreciation of the AUD in the forex market. Price of imports will decrease and price of exports will increase. decreasing AD
EVALUATION on MP its its ability to impact AD, living standards and macro goals
Strengths
No political bias/constraints: not elected by public and has no political affiliation, make decisions purely based on economic factors, gives freedom to make economically sound but politically unpopular decisions
Short implementation lag:RBA meets every month to make decision about cash rate target, gives flexibility to 'wait and see' in economy and wait for key economic date before making decisions
No financial constraints: unlike BP, it can purchase as many bonds or change the CRT without limitations, as necessary, in order to meet the domestic macro goals
Weaknesses
Long impact lag: long and variable lags as it takes time for changes in the CRT to make its way through transmission mechanisms and into the economy. eg. some households have fixed mortgage rates and therefore not immediately impacted. Greater change MP could become pro cyclical
Is blunt: changes in IR by RBA affect overall levels of saving, consumption, investment and net exports. Because economic impacts of MP are so widespread, the policy cannot precisely target particular areas of concern