Monetary Policy in Australia: A Critical Analysis of the Official Cash Rate

Running head: ECONOMIC ASSIGNMENT MBA
Economic Assignment MBA
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ECONOMIC ASSIGNMENT MBA1
Introduction
Fiscal and monetary policy are considered as two vital policy instruments for stabilizing
the economy of a nation. Monetary policy refers to a process using which the central monetary
authority of a nation determines money supply to maintain the objective of price stability and a
stable economic growth (Goodwin et al. 2015). The monetary policy in Australia involves use of
interest rate termed as official cash rate in order to affect aggregate demand, price level stability
and employment in the Australian economy. It is considered as one of the major policies to
stabilize fluctuation in business cycle. It is the responsibility of Reserve Bank of Australia to
design monetary policy by setting cash rate. Cash rate affects other interests in the economy as
well which actually influence economic activity, inflation and employment (Rba.gov.au 2019).
The essay critically examines influence of official cash rate in the country. It also evaluates
change in cash rates in the respective year of 2010 and 2018 using arguments given by RBA for
the concerned monetary policy.
Impact of changes in official cash rate
Changes in official cash rate affects overall rate of inflation and overall economic
activity. The impact of changes in official cash rate can be explained using the transmission
mechanism for monetary policy. It is difficult to quantify the impact of monetary policy though
housing market plays an important role in the transmission mechanism (Uribe and Schmitt-
Grohe 2017). A relatively lower official cash rate encourage investment resulting in an increase
in wealth and cash flow for the household. Changes in the cash rate also relate to the changes in
currency value and exchange rate. Lower interest rate means a lower value of currency leading to
a depreciation of currency. This in turn result in an increase in net export and imported inflation
because of a higher price of imported items.

ECONOMIC ASSIGNMENT MBA2
The Reserve Bank of Australia designs monetary policy in order to achieve stability in
the price level, economic prosperity and full employment. For attaining these objectives, RBA
sets an inflation target ranged between 2 and 3 percent (Rba.gov.au 2019). The main instrument
for doing this is the cash rate. Adjustment in the official cash rate affect the country through the
transmission mechanism. The simple transmission channel of monetary policy is shown in the
figure below.
Figure 1: Monetary transmission mechanism
(Source: Rba.gov.au 2019)
There are two stages of monetary transmission mechanism. In the first stage, changes in
official cash rate influence other interest rates in the economy. In the second stage, changes in
other interest rates influence inflation and economic activity of the nation (Ireland 2016). The
cash rate determines market interest rate given for overnight loans between different financial
institutions of the nation. It is the benchmark interest rate which is used for financial transaction
in the money market. Cash rate thus has a strong impact on other deposit and lending rates. The
extent of changes in interest rate due to changes in cash rate is called as ‘interest rate pass-
thorough’ (Rba.gov.au 2019).