This report will provide information about the objectives of the monetary policy and the functions of the reserve bank of Australia. Along with this, the factors that RBA consider when taking decision about the cash rate will be discussed in this report. The reason behind the decision about the unchanged cash rate of RBA will be discussed in this report. In addition to this, what will be the affect on inflation of increase in cash rate and the affect of decrease in cash rate on economy will also be discussed in this report. This report will also provide information about the affect of increase in decrease of cash rate on GDP, Inflation, Housing market, Consumption demand and business investment. Along with this, this report will also provide information about the view of student about the unchanged rate of RBA.
Monetary policy is a process by which the supply of money controlled by the monetary authority of a country. The objective of monetary policy is different in every country and it also differ by time. Following are the objectives of monetary policy:
This is the traditional objective of monetary policy. In different countries exchange stability was the main objective under gold standard. Whenever disequilibrium occur in the balance of payment of a country, this disequilibrium automatically corrected by the movement (Smets, 2014). To increase the foreign investment, developing countries pursue stable exchange. If the exchange rate is stable, than it will be very beneficial for the international trade.
This is the most important objective of monetary policy. Monetary policy helps to avoid the price inflation and deflation and this is leads the price stability. Price stability helps to enhance the confidence of public because it eliminates the price fluctuation like; inflation and deflation. Monetary policy ensures that all the income and wealth is distributed equally or not. It promotes imports and discourages the export.
Full employment refers to that economic situation where all eligible people who want job can find the job at a good wages rate. Full employment is not 100% employment. Monetary policy is mainly concern credit and currency, so the policy regarding credit and currency can overcome the problem of trade fluctuation in the economy of a country (Ball, et al., 2014). When the economy of a country face the unemployment problem than the monetary authority can help the economy by making cheap money policy. Monetary policy also helps to maintain the employment in the economy by formulating various important policies.
Increase in the goods and services produced in a country within a time period are called economic growth. According to Prof. Meier “economic growth is a process of increase in per capita income of a country after a long time period”. So the monetary policy help in the economic growth by maintaining the equilibrium between the demand and supply of the money and it also helps to increase the conditions for savings and investment (Barro, 2013).
The central bank of Australia is known as The Reserve Bank of Australia. This bank was established by the Reserve Bank Act 1959. The RBA works to encourage the smooth and safe financial system. The most important function of the RBA is to set the monetary policy of Australia. The functions of the reserve bank of Australia are as follows:
Stable currency means that currency which performs its functions properly such as; means of exchange, unit of account etc. This is very important for currency stability that the economy of the country should be strong. The reserve bank of Australia always checks the inflation in the market and tries to make the currency stable (Deans and Stewart, 2012). To stabilize the currency it is very important for the reserve bank of Australia to always check the inflation. In the simple way it can be said that with your money you can by less than what you buy yesterday so this is inflation. Thus, Reserve Bank of Australia’s function is to stabilize the currency of the country.
Full employment means all the eligible people who want to work can get the job at a good wages rate. This is also a function of reserve bank of Australia. The reserve bank of Australia making policies and doing various programs to encourage the full employment (Voigt, et al., 2011). The RBA doing targeted employment programs because there are many low wages workers and many black and Hispanic workers who are suffering from unemployment and by this program the various jobs can be created for the unemployed people.
Foreign exchange reserve is that reserve assets which country’s central bank hold to foreign currencies and this reserve helps to pay the liabilities in the same currency in which it borrowed (Vallence, 2012). The reserve bank of Australia holds and manage the foreign currency reserve of the country to pay back the foreign liabilities.
The central bank of Australia is the bank which provide banking facilities to the government of the country. The RBA helps the government in various ways like the RBA provide loan to the government and it also helps the government in the evaluation of the growth of the economy and it also provide suggestions related to money and economy to the government.
The reserve bank of Australia has the authority to issue the new currency in the country. No other bank can do this work instead of the reserve bank of Australia (Kenen, 2011).
The reserve bank of Australia is known as the bankers’ bank because this is the only bank which provide loan to the other commercial banks and control the other banks and set the interest rate.
Cash rate is the rate of interest which the reserve bank charges on the loans which it provides to the commercial banks. The cash rate is decided by the reserve bank of Australia in its economy. The cash rate can be affected by the transaction between the reserve bank and an institution.
A part of economic data is called economic indicator. The macroeconomic indicators are periodically released economic statistics which are released by government and private organizations. This indicator helps to know the economic condition of a country and it helps to analyze the current and future possibilities of investment (Louzis, et al., 2012). The main objective of the macroeconomic indicator is to forecast the exchange rate and for this there are some factors such as; the gross domestic product (GDP), Producer price index (PPI), Consumer price index (CPI), employment data and interest rate. So these are the macroeconomic indicators by which the RBA can set the exchange rate. When deciding the cash rate of Australia the RBA keep some factors in mind. On the first Tuesday of every month except January the a board meeting conduct by the RBA and in that meeting the board members decide that is there any need to change the cash rate. From the many past years the reserve bank of Australia working for the welfare of the economy and also for the welfare of the Australian people. With the help of the monetary policy the RBA control inflation and promote the stability of currency, maintain the full employment and promotes the economic and public growth. The RBA make decision whether to change or keep the official cash rate unchanged on the basis of how much money is circulating around the country. To decide whether to increase or decrease the cash rate the RBA take into account the following factors:
International Economic Condition: While deciding the cash rate the RBA consider the strength of global economy. It considers the strength of China, USA etc (Sobatka, et al., 2011).
Domestic Economic Condition: To know the domestic economic condition the reserve bank of Australia look at the employment and unemployment level of the country. Along with this the RBA look at the currency, inflation figures and the household debts.
The Stability of Financial Markets: The reserve bank of Australia evaluates the performance of the financial institutions and also evaluates the lending and deposit accounts rate. The RBA also look at how the financial institutions working in wholesale markets (Schumaker, et al., 2012).
Review of the previous decision: At the final step, the reserve bank of Australia reviews its previous decisions and evaluates that how their previous decision affected the local banking. The review of the previous decision helps to know the impact of inflation on their projection and it also helps to know about the future growth.
The reserve bank of Australia evaluate the above factors and then take decision on the basis of the factors that the cash rate should be increase or decrease or should remain the same.
3. On 1st August 2017, in the meeting of board the reserve bank of Australia decided to keep the cash rate unchanged at 1.5%. The main reason why the RBA did not raise the cash rate was the past weak inflation reading. The experts expected that the inflation will rise 0.4% but the inflation rise only 0.2%. The governor of the RBA, Dr. Philip Lowe said that the global economy condition will improve in the future. The reserve bank of Australia said that the low level of interest will beneficial for the Australian economy. According to the statement of the RBA, in the meeting of board, the members take decision to remain unchanged the cash rate because it will help in the sustainable growth in the economy and will also help to achieve the inflation rate. The value of Australian dollar was raised above US80¢, and it was raised second time in two weeks (Moessner, et al., 2017). The governor of the RBA said that the forecast for the Australian economy was unchanged. According to Dr. Philip Lowe the reason behind the unchanged cash rate is that the lower cash rate will encourage the household borrowing and will decrease the risk that economy is facing. To support this decision the RBA said that the decision which they made is just to support the borrowing of the household. The RBA said that the price growth in Sydney was slow and the interest rate was high that attracting the investors. The reason behind the unchanged rate was the increase in the inflation rate in the over few years. Inflation is that condition where the prices of the goods and services increase and the inflation is measured as annual percentage change. With the decision of unchanged cash rate the RBA also stated that the inflation will grow over 3 percent over the next couple of years and the inflation will increase the economy by A$1.7 trillion. The governor of the RBA said that the export of the country is rising continuously and investment in the non mining is also increasing. The consumption is same but the earning of the households remained low (Otto and Voss, 2011). The RBA said that if they dope the rates than it will increase the housing market and if they increase the rates than it will decrease the consumption and the investment and also affect the Australian dollar. The Governor of the RBA also stated that the condition is the housing market is not the same around the country. In some markets the prices are strong and in other markets prices are declined, so deciding the rate is not so easy. The RBA expected that the cash rate will increase in the mid of 2018 by 0.25% and the cash rate will be 1.75%. The cash rate of the RBA can be understood from the following graph:
From the above graph it is shown that the cash rate of RBA is remain unchanged at 1.5%. The changed in the interest rates in Australia in long term can be understood from the following graph:
This graph clearly showing that the cash rate of RBA is changing from last couple of years but in the 2017 it is unchanged and same as the rate of 2016.
The money market is a model of economic which describe the demand and supply in the country. The money market equilibrium is that point where the quantity of money demanded is equal to the quantity of money supply (Vazirani and Yannakakis, 2011). The money market equilibrium can be understood from the following graph:
Monetary transmission mechanism is a process by which the decisions related to monetary policy passed on to the businesses and households through the financial markets. The monetary decisions influence the aggregate demand, amount of money and interest rates (Lewis and Poilly, 2012).
Inflation is that condition where the prices of the goods and services increase. In broad sense it can be said that the inflation is increase in the cost of living as a result of increase in the price of goods and services. If the cash rate of the country will low than more people can borrow money from the banks and this increase the spending of people and it increase the inflation. By increasing the cash rate from 1.5% to 2% the borrowing can be decreased and people will spend less money, the savings will higher and the economy slows and inflation decrease (Barr and Diamond, 2011). When the people of a country spend more money and the inflation increases in a country than the reserve bank increase the cash rate so the people spend less money and to maintain the inflation. The changes in the GDP of Australia because of the increased in cash rate in past few years can be understood from the following graph:
The above graph clearly describe that the GDP of Australia faced fluctuation in last few years and the GDP is affected by the cash rate that the reserve bank of Australia set for the economy. The reserve bank of Australia increase the cash rate and the public borrow less money and spend less than the GDP of the country decrease.
Apposite to this when reserve bank decreases the cash rate it means the interest rate will also decrease. Low interest rate increases the borrowing. If the reserve bank decrease the cash rate from 1.5% to 1% this clearly increases the spending and investment of the people of the country. The decrease in the cash rate directly increases the aggregate demand and economic growth. If the banks will provide loans in cheaper interest rate than most of the people want to borrow the money and many businessman also borrow the money and invest that money into businesses. If the interest will low than it will provide low interest on saving also so this decreases the savings and increases the spending. Reserve bank decrease the cash rate when the public decrease the spending and borrowing and increase their savings. Low cash rate increases the inflation. The increase and decrease in the inflation of Australia can be understood from the following graph:
From the above graph it can be understand that in 2014 the cash rate was higher that’s why the inflation was higher but in 2017 the cash rate of Australia is 1.5% and this is low that’s why the inflation in Jan. 2017 is lower than the inflation of 2014.
Increasing the cash rate means increasing the interest rate of the commercial banks. The public will earn more interest on savings and the public will also pay more interest on the borrowing. On the other hand decrease in the cash rate means the public can borrow more money from the banks on cheap interest rate and businesses can also borrow money to investment. The effect of increase or decrease cash rate can be understood from the following discussion:
If the cash rate will increase than the consumers cannot borrow money from the banks and also they want to save the money to earn higher interest so they will not spend their money to buy goods and services. Thus, the consumption demand will decrease because of the increase in cash rate. On the other hand if the cash rate will decrease than the consumers can borrow more money and will decrease their savings and will spend more money (Diamond and Rajan, 2012). This will increase the consumption demand. For example; if the RBA increase the cash rate from 1.5% to 2% than the consumption demand in Australia will decrease and if the cash rate decrease from 1.5% to 1% than the consumption demand will increase.
If the cash rate will increase than it will negatively affect the business investment. For the investment in the business an investor will borrow money from the banks and if the bank will provide loan on higher interest rate than no one wanted to borrow money for the investment and indirectly the investment will decrease (De Mel, et al., 2012). If the cash rate decrease than the business investment will increase. For example; if the RBA increase the rate from 1% to 1.5% than the investors will not borrow money and opposite to this if the RBA decrease the cash rate from 1% to 0.75% than the business investment will increase.
The increase cash rate also affects the GDP of a country. Higher cash rate means the public cannot borrow money and will increase the savings and will spend less and this negatively affects the GDP. On the other hand if the cash rate decrease than the public will spend more money and decrease their savings and this increase the GDP.. For example; if the RBA increase the cash rate from 1.5% to 2 % than the public will not borrow the money and will increase their savings. And if the cash rate decrease from 1.5% to 1% than the public will spend more money and GDP will grow.
Inflation is that situation where price of goods and services increases. If the cash rate will increase than the inflation will also increase and if the cash rate will decrease than the inflation will also decrease (Eggertsson,2011). For example; if RBA increases the cash rate from 1% to 1.5% than the inflation will increase and opposite to this if RBA decrease the cash rate from 1% to 0.5% than the inflation will also decrease.
If the reserve bank increases the cash rate than the public cannot borrow money to buy a house and opposite to this id the cash rate decrease than the public can borrow money and than more people will buy house. For example; of RBA increases the rate from 2% to 2.5% than housing market will suffer from loss and if the cash rate decrease from 2% to 1% than more people will buy houses and housing market will earn profit.
The historical low interest rate of 1.50% is not sustainable to achieve long run economic growth because changes in the cash rate required after some time. If the cash rate will remain same than the people who are not willing to invest money or not borrowing the money because of the higher interest rate will never borrow the money and will not increase their standard of living. The cash rate is depends on the inflation level so if the inflation will change in future than the cash rate will be changed.
Conclusion
From the above discussion it can be concluded that there are some objectives of monetary policy such as; stability of exchange, price stability, full employment etc. It can be also concluded that Maintenance of full employment , managing foreign currency, issuing the notes etc. are the functions of RBA. It can be also concluded that when setting the cash rate the RBA consider some factors such as; international economic condition, domestic economic condition and the stability of financial market. It can be also concluded that the RBA decided to keep the rate unchanged for the growth of the economy. Along with this it can be concluded that if the interest rate will increase from 1.5% to 2% than the inflation will also increase and if the cash rate decrease from 1.5% to 1% than the public can borrow more money and spend more. In addition to this, it can be conclude that there are some positive and negative effect of increase and decrease of cash rate on GDP, inflation, business environment, housing market and consumption demand. Along with this it can be concluded that with constant cash rte the RBA cannot achieve the long term growth.
References
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