The actions taken by the Reserve Bank of Australia to influence the cost and supply of money in the economy are referred to as the monetary policy. The main tools through which the monetary policy influences the market operations is the interest rate that is paid on the loans from the money market. Manipulating the interest rate is the main tool of RBA to influence its monetary policy. RBA is the central bank of Australia; and it is the role of the central bank to ensure price stability by controlling the supply of money. So, a stabilizing role is played by the monetary policy in order to influence the growth of the economy.
Maintaining the price stability is the major contribution of the monetary policy to the sustainable growth of the economy. Lower price is said to have close associations with sustainable growth in the long term; inflation damages the welfare and the performance of the economy (Ciro, 2012). So, monetary policy not only impacts the costs of financing but also the credit availability and the willingness of the banks to finance.
The central objectives of the monetary policy are: maintaining full level of employment; containing inflation; and achieving a sustainable growth in the economy in the long run. In general, the monetary policy aims at improving the livings standards of the people. According to RBA, an average growth rate of 3% is targeted for Australia and the monetary policy helps to ensure the creation of an environment that is conductive of non-inflationary growth. The RBA targets the consumer price inflation at 2-3% annually; by controlling the level of inflation, the value of the money is preserved (Baxa, Horv'ath and Vavs'ivcek, 2011). This rate of inflation is sufficiently low; this means that such a low level of inflation would not materially distort any kind of economic decisions.
It is the primary responsibility of the Reserve Bank Board to formulate the monetary policy. On the first Tuesday of every month except January, the Board meeting is held. The required data to be used in these meetings include a detailed account of the developments taken place in the Australian economy as well as the major economic development around the world; this further includes the trends of the financial markets both domestically and internationally. Each paper also contains certain recommendations based on the data.
- The RBA implements the monetary policy in the cash market by using the operations of the domestic market. The selling and purchasing of the Commonwealth Government Securities is the process to influence the cash rate or the interest rate. If the effect of the monetary policy is to be altered, the interest rate is changes. There are three stances of the monetary policy: contractionary stance, expansionary stance and the neutral stance. There are cycles of expansion, recession and recovery that the businesses undergo. The length and timing of these cycles are influenced by the monetary policies. The economy grows in the expansion phase; more jobs are added to businesses and the spending of the consumer increases. When a peak is reached in this phase, the economy overheats and the central bank decides to raise the rates of interest so that inflation can be staved off (Ennis and Keister, 2008). The rate is cut and so is the government spending; this is important to recharge the economy. The economy reaches the lowest bottom of the cycle and then starts resuming into a new phase of expansion.
When the RBA intends to ease the monetary policy, it lowers the rate of interest in the cash market. It purchases the Commonwealth Government Securities that leads to increasing the cash supply and eventually the liquidity of the cash market increases. Lower interest rate means that the cost of borrowing is lower and so commercial lending increases as the banks would lend their excess liquidity. In other case, when RBA plans to tighten its monetary policy, it raises the cash rate and sells the Commonwealth Government Securities in the cash market. Thus, it decreases the supply of cash and creates a deficit in liquidity. Ultimately a downward pressure is put on the interest rate as the banks now require borrowing liquidity to maintain the standards of liquidity required by the RBA and so, it results in raising the costs of borrowing.
When the interest rate is lower, businesses have lower interest expense and so the consumers have more disposable income to be spent. Eventually, this leads to generating more revenue and thus, higher profits for the business. When the mortgage rate is lower, more existing mortgages are being refinanced; home-buying activities are spurred leading to a growth in the construction industry. When the interest rates are higher, the businesses have high interest expense which means low revenue generation and lesser profits. In this scenario, borrowing and spending shall decrease while saving shall rise. A rise in the rate of interest to restrain the inflation leads to demand contraction and eventually reduction in inflation.
- The Board meeting held on 7th April 2009, decided to lower the rate of interest by 25 basis points to become 3.0%. During the early months of the year, the global economy was contracting and most of the countries were making use of the economic policy stimulus. The condition of the global economy was considerably uncertain and the asset quality of the financial institutions was being badly impacted (Reserve Bank of Australia, 2009). Even though Australia wasn’t that bad affected as compared to its trading partners, but its economy was contracting. Capacity utilization had fallen and labor weakening was in demand leading to a decline in the growth of labor costs. It was assumed that inflation would lower as compared to the past two years. Even though the credit was rising for the owner-occupied housing, the credit demand remained overall weak. With low market and mortgage rates, the rates of business loans remained lower. The main initiative of the monetary policy remained providing considerable support to the demand in the domestic economy.
But by the end of 2009, there was a substantial rise in the global economy. The policy settings of the global economy were focused on expansion. During this time, the prospects for the trading partners of Australia were better like Asia and China. The economic conditions of Australia became stronger leading to a recovery in the confidence. Due to the policy initiatives, spending would rise and private investments would become strong. The housing credit growth was solid and the prices rose appreciably within the last six months. Due to the tighter lending standards, companies reduced their leverage and the borrowing by the businesses declined (Reserve Bank of Australia, 2009). The access to debt market of the large companies had been improving and the investor confidence had risen; the better-than-expected economic conditions made the investors willing to accept risk.
In the early 2009, the cash rate was lowered as the expectation was that the economic conditions would remain very weak (Wassener and Foley, 2009). Now, the growth seemed to be trend for the coming year and the risk of economic contraction had passed as the inflation also reached close to the target. The board decided to lessen the economic stimulus that had been provided by the monetary policy. The main cash rate was raised to 3.25%; Australia became the first country to raise the rate again. The governor of the central bank, Glenn Stevens said, “Economic conditions in Australia have been stronger than expected and measures of confidence have recovered” (Wassener and Foley, 2009). Australia benefitted a lot from the emerging economic powerhouses of Asia.
In April 2010, on Tuesday, the RBA decided to raise the interest rate to 4.25%; in the consecutive six months, this was the fifth rate increase by RBA (Ciro, 2012). Since the global financial crisis of 2008, it became the first major economy to nudge its cost of borrowing from October 2009. The decision by RBA was based on the stance that despite the prior increases in the rates of interest, the housing market remained strong and so, another raise was decided. The regional economist at HSBC, Fred Neumann wrote, “The R.B.A. appears to have decided on a more pre-emptive path: Raise rates now to deflate the housing bubble before it gets into full swing” (Wassener, 2010). Since Oct 7, the cash rate had been risen by 1.25% points. Another important reason behind this rise was the strong economic growth of the country; the mineral wealth of Australia is being voraciously demanded by China. In addition, the banking system of Australia wasn’t also too badly impacted by the global financial crisis of 2008.
It was discussed in the minutes of the meeting that due to the rising terms of trade of Australia, the output growth is expected to increase that of the prior year. Even the unemployment rate was lesser than expectation; the business credit lessening was declining indicating that lender confidence has been boosted and they seem to be willing to lend credit to borrowers (Trading Economics, 2010). Even the inflation had declined from the peak in 2008 and led to a slowing down of the labor costs in the private sector. The board identified that the economy was expecting to be growing and inflation would remain stable, so it was the right time to raise the interest rates in the month of April.
As the country performed strongly in 2010, the global economic growth moderated in 2011. Around the mid-year, the expansion pace started increasing in Asia and United States while the growth of China slowed down. The growth in demand had been quiet strong and growth in output was also close to trend (Reserve Bank of Australia, 2011). The investment in resource sector was very strong and the household behavior had started changing in almost all the sectors. The conditions of the labor market had softened; the asset price had declined and credit growth remained subdued (Pascoe, 2012). All the information suggested that the cash rate could be moderately reduced.
At the end of 2013, the board decided to leave the cash rate unchanged at 2.5%. The commodity prices had declined and the overall inflation has been well contained in most countries. The overall conditions of the global financial economy seemed accommodative while the long-term rate of interest remained low leaving an ample amount of funding for the borrowers (McGrath, 2013). The Australian economy has seen a rise in the unemployment rate recently and the mining investment seems to remain low. Although the private demand is expected to rise but the public spending was forecasted to remain weak. The bank assessed that the inflation would remain consistent with the target for the upcoming two years. The monetary policy that was eased in 2011 supported the interest-sensitive spending and also the value of assets. The long-term impacts of all those decisions are still coming. As the returns on the low-risk assets had declined, there has been a shift towards saving (Reserve Bank of Australia, 2013). The housing markets and the equity market were strong and supported investment. As the settings of monetary policy seemed appropriate keeping most targets met, the Board decided not to change the interest rate.
- Overall, during 2010 and 2013, the output in the Australian economy rose by 9%; half a million people got jobs; unemployment rate remained at 5.4% and the inflation was at an average of 2.5% (Edwards, 2010). This showed that during these three years, the growth in the country was close to trend and relatively stable. The Australian Board took the most appropriate measures during the time period of 2006-2013. It is evident from the fact that the economy was the first to rise back after the global financial crisis and it was only because it had taken wise steps during the period of crisis. The objective inflation during that time as decided by RBA was to keep the consumer price inflation to only 2-3% so that all the long-term and short-term consideration could be balanced (Smales, 2012). The Board had analyzed the situation in the most appropriate manner and used all the data correctly at the right time to decide about the changing circumstances. The most important aspect in the whole scenario is the wise decision taken by the Board to provide stimulus to the economy when required and also to limit that stimulus at the most critical time. Specially by studying the trends of its trading partners, Australia has taken the right decisions at the right time and then after reaching its target, it decided to remain stable and not alter its monetary policy; this was because all the settings seemed to be effective for the country. The uncertainty of the global economies could have adversely affected the domestic economy if the monetary settings would have been altered.
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