Monetary Policy and the Australian Economy: An Analysis of the Reserve Bank's Decision

Running head: ECONOMICS
Economics
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ECONOMICS
Table of Contents
Introduction................................................................................................................................2
Objective of monetary policy.....................................................................................................2
Functions of money....................................................................................................................4
Functions of Reserve Bank of Australia....................................................................................5
Money market equilibrium.........................................................................................................5
Monetary Transmission mechanism..........................................................................................7
Effect of domestic and global macroeconomic indicators on cash rate decision.......................9
Domestic economic environment...........................................................................................9
Global economic environment.............................................................................................13
Explanation for holding cash rate unchanged at 1.50 percent.................................................13
Economic growth and long term determinant of growth.........................................................14
Conclusion................................................................................................................................15
References................................................................................................................................16
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ECONOMICS
Introduction
The paper prepares a case study on current state of Australian economy with
particular focus on monetary policy decision of Reserve Bank of Australia. The monetary
policy decision of RBA based on analysis of overall macroeconomic environment of
Australia with special attention given on achieving stable growth and price level. After a
number of adjustment in the official cash rate RBA has kept the interest rate fixed at 1.50
percent since August 2016 to December 2018. At the last meeting of RBA held on December
4, 2018 RBA has announced its decision to leave cash rate at 1.50 percent. The decision has
been influenced by both domestic and global economic condition. There is continuous
expansion of global economy with most of the advanced economy maintaining a relatively
low unemployment rate. The ongoing trade tension has shown some signs of economic
tensions. The current state of financial market in most of the advanced economies has been
tightened somewhat. There is a slight decline in equality price along with a higher credit
spread. As against the global economic condition, the economy of Australia is performing
quite well. Currently, the economy is growing at an average rate of 3.5 percent. The slow
growth resource export is expected to slow down growth in 2020. The domestic price level
has remained stable along with a positive outlook for labor market. The condition of housing
market also remains relatively stable. Housing market of Australia is receiving continuous
support from the low interest rate.
Objective of monetary policy
Definition: Monetary policy is defined as a macroeconomic policy that is designed by central
bank of a nation.
Assumption: The monetary policy is assumed to be a demand sided policy that works
through the instrument of money supply and interest rate and helps the economy to attain
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ECONOMICS
macroeconomic objectives such as price level stability, consumption, economic growth and
liquidity.
Analysis: The main objective of monetary policy is to keep inflation rate within the stable
targeted rate. Primary objectives of monetary policy are briefly discussed below.
Stability in price
One of the primary objectives of monetary policy is to maintain a stability in domestic
price level. The central bank adjusts supply of money to keep the price level stable. During
high inflationary pressure, the central bank takes tight monetary policy through raising
interest rate (Gali, 2018). During deflation central bank takes expansionary monetary policy
in terms of lowering the interest rate.
Stability in exchange rate
In addition to marinating stability in domestic price level, monetary policy also plays
an important role in maintaining stability in exchange rate. Central bank uses foreign
exchange reserve to maintain stability in relative price of currency. The policy of devaluation
or evaluation are used to keep stability in the external sector.
Neutrality of money
Another priority of monetary policy is maintaining neutrality of money. The neutrality
of money refers to the assumption that fluctuation in money supply does not affect real
variables in an economy. By keeping money neutral, the economy can be protected from
economic fluctuation and volatility in the price level.
Economic growth
Achieving a stable economic growth is one objective of monetary policy. Using
monetary policy, a balance can be maintained between money demand and productive
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