Role of Reserve Bank of Australia in Determining and Implementing Monetary Policies

This paper discusses the role of the Reserve Bank of Australia in determining and implementing monetary policies aimed at levels of inflation, employment, and investment. It also explains the main objectives of monetary policy, functions of money and the Reserve Bank of Australia.

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Introduction
The Reserve Bank of Australia (RBA) is the sole institution responsible for maintenance
of a stable macroeconomic environment. The bank monitors levels of inflation, unemployment,
Gross Domestic Product (GDP), consumption, and exchange rates and initiates mechanisms that
seek to ensure that business environment is sustainable (Bernanke, Antonovics & Frank, 2015).
The bank aids the Australian government by ensuring working to create an enabling environment
for government plans and projects. The Reserve Bank Act 1959 provides the selection of a board
of directors and outlines its roles and responsibilities. The board is the organ of the RBA that is
responsible for establishing bank policies except those related to payment systems (Reserve
Bank of Australia, n.d). The board ensures that monetary and banking policies present utmost
optimum benefits to the People of Australia. It consists of nine members namely; Governor, His
deputy, Treasury Secretary, and six non-executive members. The Board meets eleven times
annually except in February to discuss Australian macroeconomic environment and propose
macroeconomic policies which are then implemented by the bank.
This paper discusses the role of the Reserve Bank of Australia in determining and
implementing monetary polies aimed levels of inflation, employment, and investment. The first
part highlights factors considered by RBA in adjusting macroeconomic variables. In addition, the
objectives of monetary policies, importance of money, and roles of the Australian central bank
are discussed. Finally, the study highlights reasons why the central bank has maintained the cash
rate constant for two years.
Question 1. Why RBA considers Domestic and Global Indicators in making monetary
policy decisions

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Inflation is the general rise in price levels in an economy. High rates of inflation reduces
the purchasing power of households and the entire economy since prices of goods and services
rise (Bos, 2014). Monetary policies and fiscal policies are the available tools used by RBA in
controlling inflation. The amount of money in circulation in an economy affects the level of
prices such that the higher the money supply, the greater the levels of inflation (Egan &
Gumaraes, 2018). The reserve bank of Australia’s main monetary policy tool is the cash rate.
Cash rate is interest rate on overnight loans traded in the money market. The cash rate works by
influencing the general behavior of borrowers, lenders, and amount of prevailing investment
activities which ultimately impact inflation levels. Normally, before the RBA board sits, the
department of economic analysis presents them with a macroeconomic analysis report that
highlights macroeconomic patterns locally and internationally.
According to RBA’s November monetary policy report, the Board decided to retain the
cash rate at 1.5% considering the economic environment locally in Australia and internationally.
The cash rate is not determined arbitrarily. The decisions are based on factual historical patterns,
current information, and predicted patterns of the macroeconomic variables. The board identified
global economic expansion, decline in Chinas economic growth, decline in global inflation,
appreciation of US dollar as reasons that influenced its decision to retain the cash rate. Locally,
the RBA considers the rate and direction of economic growth so as to align its macroeconomic
policies with country economic targets.
The RBA board considers inflation levels and economic activity in Australia while
determining the appropriate cash rate. Whenever inflation is high, the RBA is triggered to raise
the cash rate. A high cash rate influences commercial banks to raise interest rates on loans which
limits demand and lending growth (Eiteman, Stonehill & Moffett, 2016). Normally, individuals’

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consumption of loans decline when lending rates are high. Money supply in the economy
declines and therefore, reducing the levels of inflation. When inflation is low, the RBA might be
triggered to lower the cash rate which influences lenders to lower interest rates. Reduced interest
rates increases demand for loans which increases economic activity and economic growth (Hong
& Li, 2017). Money supply in the economy will increase stabilizing inflation around the required
rate. The RBA as an agent of the government is tasked with the role of adjusting macroeconomic
variables to support government targets of full employment and economic growth which is
achieved by a keeping the cash rate low.
The world financial environment has become interlinked and hence the Australian
economy does not operate in isolation. Therefore, RBA has to consider global macroeconomic
indicators in deciding the appropriate. The objectives of the cash rates are more domestic
although impact is felt both locally and internationally. In July 2018, the RBA set the cash rate at
an historic low (Reserve Bank of Australia, 2018). Similarly, in China, United States, United
Kingdom, the interest rates were at historic lows. Australia exports its products to other countries
including China and the United States while it imports some. Therefore, changes in foreign
exchange rates is significantly of interest to Australia. The country is determined to enhance the
strength of the Australian Dollar relative to the US dollar and other commonly traded currencies.
Question 2: Explain the main objectives of monetary policy. List and describe the main
functions of money and the Reserve Bank of Australia.
The main goals of monetary policies is to maintain price stability, full employment,
economic growth, and welfare of Australian citizens. The RBA has set a medium term inflation
target between 2 and 3 percent. Successfully maintaining inflation rates within the target ensures
that the value of the Australian dollar is stable which promotes sustainable economic growth.

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The price stability in the economy ensures that the purchasing power of households in
appropriate enabling them to spend and save for the future. Governments are responsible form
enhancing absorption of its citizens in to the job market through employment. Australia like
other countries uses monetary policies to control the level of unemployment. Therefore, a
significant objective of monetary policies is the achievement of full employment locally.
According to Keynesian economists, the rate of inflation in a country is inversely proportional to
the rate of unemployment on the assumption that all other factors affecting employment remain
constant (Ehrenberg & Smith, 2016). The maintenance of stable levels of inflation in Australia
spurs economic growth witnessed through increased investments. The increase in investments
demands for the expansion of the work force leading to increased employment. Deflation
characterized by a decline in money supply reduces economic growth and reduces demand of
labor. This results to an increase in the rate of unemployment in the economy.

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Functions of money
Initially, there was no money. People transacted goods for goods in what was known as
barter trade. However, trade advanced with time leading to the introduction of money in form of
coins and paper and now virtual money. It is a medium of exchange since people can trade their
goods and services in return of money (Gopinath, Helpman & Rogoff, 2014). The traders, both
buyer no longer need to have double coincidence of wants as it was in barter trade.
It is also a unit of account since almost all products and services possess a monetary
value. This function has facilitated costing, accounting, and planning. The relative cost of
products can now be established easily.
Money is also a store of wealth because individuals can keep their wealth in form of
money. Money is the most liquid asset and hence the most convenient way of storing wealth.
Many people set aside a portion of their income as savings future investment or retirement plans.
Owners of perishable products might decide to convert them to money and hence it is a store of
value (Miller & Benjamin, 2017).
Finally, money as a standard of deferred payments. It facilitates future payments such as
hire purchase, mortgage and credit facilities. The future payment is in most cases conducted
paying in to consideration changes in the value as a result of inflation. Payment of salaries and
debt obligations are made possible using money.
Functions of Reserve bank of Australia
The RBA is an important entity that manages the financial and economic affairs of
Australia. The bank is the sole issuer of the Australian currency. It conducts the printing, release,
and controlling the level of money supply in the economy.

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The RBA is the financial and economic advisor of the government of Australia. The state
relies on counsel from the RBA board and organs. The bank employs highly experienced
economic analysts who can be relied upon to offer counsel to the government on financial issues.
The bank manages and controls the country’s gold and foreign reserves at levels that
ensure that ensure that the Australian dollar remains strong relative to foreign currencies.
The RBA is the government banker. The government holds an account with the bank
allowing it to make deposits and payments. It is also the banker’s bank facilitating some financial
transactions between commercial banks (Othman et. al, 2017). Commercial banks can borrow
from the RBA when they have exhausted all other available avenues.
The RBA supervises banking in Australia. It licenses commercial banks and creates
policies that promote a stable and efficient financial system.
Question 3: On 7-August-2018, the Governor of the RBA, Dr Philip Lowe, decided to leave
the official cash rate unchanged at 1.50 percent as house prices continue to fall. Why did
the RBA keep the cash rate unchanged for the last 2 years? Justify your answer with
reasons and evidence.
The reserve bank of Australia’s main monetary policy tool is the cash rate which is the
interest rate for overnight loans. Commercial banks borrow cash from each other to meet their
customer cash demands in what is known as overnight loans. The cash rate together with other
factors determines the interest rates set by commercial banks and other lenders. In August 2018,
RBA retained the cash rate at 1.5% (Reserve Bank of Australia, n.d). The RBA noted that as per
its objective of promoting the welfare of individuals, the board decided to protect vulnerable

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holders of loans from economic shocks. Raising the cash rate could have reduced the disposable
income of households which reduces their purchasing power.
Secondly, the period from April to July 2018 was characterized by a decline in the cost of
housing. Noting the importance of affordable housing to the people of Australia, the RBA
decided to retain the cash rate since its increase could exert pressure on the country’s housing
market triggering a rise in housing costs. The largest housing markets in Australia are the large
cities of Melbourne and Sydney. Also, the June consumer price index was below the target
placed by the reserve bank of Australia influencing RBA to retain the cash rate to avoid
triggering greater inflation.
Consumer sentiment measures the opinion of consumers regarding the economic health
of the country. The sentiment during the period was characterized by dissatisfaction among the
member of the public. Citizens felt the impact of high prices of fuel, weak wages, and declining
cost of housing. Finally, Noting the RBA’s objective of ensuring full employment. The RBA
decided to retain the cash rate at 1.5% to promote economic growth which boosts employment.
Question 4: Illustrate and explain using the money market equilibrium model and
monetary transmission mechanism how an increase in the cash rate from 1.5% to 2%
would help to keep inflation within the target rate, and how a further decrease from 1.5%
to 1 % in the cash rate would help to stimulate the economy.
The diagram below shows the relationship between cash rate and loanable funds.
Loanable funds influence the amount of money in circulation in the economy which resultantly
affect inflation, economic growth, and unemployment rate.

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Increasing the cash rate from 1.5% to 2% increases the cost of mortgages and other loans.
Households and businesses will reduce consumption of loans reducing the supply of money in
the economy. The impact of this would be a decline in inflation, economic growth, and
employment. Household consumption will decline since people would have less cash to spend.
Most would prefer to work with their income only. Business investments would decline because
businesses would work with less debt because of high cost of loans leading to shrinking of GDP
(Phaneuf & Requite, 2016). The housing market would also shrink because few investors would
find the market lucrative.
Reducing the tax rate to 1% would prompt lenders to reduce interest rates on loans. There
would be an increased borrowing which increases household consumption and business
investment. The supply of money circulating in the economy will be greater triggering a rise in
inflation rates. The rise in business investment increases Australia’s gross domestic product. The
housing market will also attract greater investment leading to its expansion.

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In particular, discuss the effect on household consumption, business investment, GDP,
inflation and housing market. Describe the circumstances in which the RBA Board might
increase the cash rate.
The RBA lastly increased cash rate in November 2010. Increasing cash rate is similar to
increasing interest rates on loans. High consumer prices resulting from prevailing terms of trade
might influence the RBA to raise cash rate so as to curb further increase in consumer prices.
The RBA is responsible for keeping the value of the Australian currency strong relative to other
currencies. Higher exchange rates night trigger RBA to increase cash rate so as reduce money in
circulation and as a result leading to strengthening of the local currency.
When the RBA predict a likely expansionary shock resulting from high trade terms, it considers
raising cash rate. Hyperinflation my lead to reduced purchasing power of customers which
increases unemployment and welfare of citizens.
Question 5: Define economic growth. What are the determinants of long-run economic
growth?
Economic growth is the increase in a country’s productive capacity measured by the
percentage change in the gross domestic product. Long-run economic growth is sustainable
economic growth. Productivity growth is the proportion of economic output to corresponding
economic inputs. When firms produce more of products, they benefit from economies of scale
which facilitate them to lower the cost of production.
Demographic changes affect economic growth. The age structure of a society determines
the dependency ratio. The lower the dependency ratio, the higher the prospects of economic
growth (Ehrenberg & Smith, 2016). The pattern of age structure of citizens affects employment.

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When the youthful population is huge, the country can utilize their energy and innovative
capabilities in spearheading development. However, a population dominated by unemployed
youth promotes crime which might curtail economic growth. The availability of vast natural
resources in the economy promotes sustainable growth since it can be exploited in to the future.
Labor force participation is defined as amount of labor available in an economy. When
development is high, more people would be absorbed in to the labor market. This promotes
exchange of ideas and innovative ideas which support the economy’s path towards economic
growth.
Is the historically low interest rate of 1.50 percent (from August 2016 until the August
2018) sustainable to achieve long-run economic growth?
Yes. The historically cash rate of 1.5 percent maintained by Reserve Bank of Australia
for 2 years supported long-run economic growth. The rate fulfilled the RBAs objective of full
employment, price stability, and economic growth (Reserve Bank of Australia, n.d). Specifically,
the RBA aimed at boosting economic growth in the country by enabling it to boom as it
diversified away from dependence on mining. The rate also maintained unemployment low by
creating opportunities for youth to get employed. The RBA noted a decline in wages growth
although the rate was expected to rise in the long run. Low cost of loans promotes economic
growth since investment loans are affordable for investors.
Conclusion
The reserve bank of Australia considers both domestic and international macroeconomic
factors when deciding on the appropriate cash rate in their monthly monetary policy meetings.
Past, present and projections of domestic macroeconomic information such as economic growth,
unemployment rates, and foreign exchange rates enable the board to select appropriate cash rate

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that promotes its objectives of fostering economic growth, full employment, and economic
stability. Globalization and international trade has also made financial systems interlinked such
changes in interest rates, trade policies, and economic growth in United States, Europe, China
among other countries affects macroeconomic indicators in Australia. The RBA’s role is to
promote macroeconomic policies by seeking to enable the country achieve full employment,
economic growth, and stability. Long-run economic growth is determined by a country’s
demographic factors, labor force participation, and productive capacity.

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Reserve Bank of Australia (2009) Statement by Glenn Stevens, Governor: Monetary Policy
[online]. Available from: https://www.rba.gov.au/media-releases/2009/mr-09-28.html [Accessed
10 October 2018].
Reserve Bank of Australia (no date) About the RBA [online]. Available from:
https://www.rba.gov.au/about-rba/ [Accessed 10 October 2018)
Reserve Bank of Australia (no date) Monetary Policy [online]. Available from:
https://www.rba.gov.au/monetary-policy/ [Accessed 10 October 2018)
Reserve Bank of Australia (2018) Media and release [online]. Available from:
https://www.rba.gov.au/media-releases/2018/mr-18-17.html [Accessed 10 October 2018]