Transmission of Monetary Policies by RBA

This article discusses the reasons why interest rates and exchange rates change over time in Australia. It explains the complex relationship between inflation, interest rates, and exchange rates and how the RBA balances them. The article also explores the effects of financial policies on inflation and exchange rates and how they are transmitted.

Running head: TRANSMISSION OF MONETARY POLICIES BY RBA 1
Transmission of Monetary Policies by RBA
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Reasons Why the Interest Rates and the Exchange Rates Change Over Time
Inflation has a negative implication on the value of a currency and the exchange rates.
For that reason, the RBA board hold sessions to evaluate the changes in financial policies in
Australia. High rates of inflation are likely to negatively impact the exchange rates in Australia.
Interest rates are highly related to inflation rates because both influence the exchange rates. The
RBA is charged with the responsibility of balancing the inflation rate, the exchange rates, and the
interest rates but the connection between the three is complex making the balancing difficult to
accomplish (Ghosh et al, 2016).
The main reason for an increase in inflation in Australia is due to an increase in spending.
High inflation results to hiking of prices for commodities within the economy making the
exchange rates for the country to be very poor as compared to currencies of other countries
(Atkin et al, 2017). To maintain inflation to standard levels, the RBA has to employ the
contractionary policy with the goal of reducing cash flow within the economy by increasing the
interest rates and reducing the bond prices. This result in a reduction in spending because the
cash availability has been decreased.
The concept of purchasing power parity requires that the exchange rates amongst two
nations to varying so as to balance the purchasing powers between the two countries. If one
country is experiencing a higher inflation as compared to its partner, its exchange rates will
appear to depreciate to overcome a continuous deficit of competitiveness. The effects of financial
policies can also be displayed practically. Statistics suggest that reducing cash tariffs by 100
source point results to financial activity, with GDP being ½% to ¾% advanced than else it could
have been in a period of two years (Borio et al, 2017). The inflation rate normally increases by

TRANSMISSION OF MONETARY POLICIES BY RBA 3
approximately ¼% point over a period of two years. Usually, it requires about one or two years
for deviations in exchange rates to influence inflation and interest rates fully.
Figure 1: Illustration of transmission of financial policies.
Therefore, through higher import prices, the rate of exchange directly affects
inflation. That is; lowering the Australian dollar and increase the prices of foreign consumer
merchandises like cars, furniture, and foods. Inflation can also indirectly upsurge as a result of
local producers who manufacture similar items to expand their margins (Manalo et al, 2015).
Depending on the extent of competition experienced in differing sectors, the high prices may be
transferred to retail products therefore indirectly influencing to higher rates of inflation. A
reduction in exchange rates can, therefore, be related to imported inflation.

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References
Ghosh, A. R., Ostry, J. D., & Chamon, M. (2016). Two targets, two instruments: monetary and
exchange rate policies in emerging market economies. Journal of International Money
and Finance, 60, 172-196.
Atkin, T., & La Cava, G. (2017). The Transmission of Monetary Policy: How Does It
Work? .RBA Bulletin, 7(4), 01-08.
Borio, C. E., & Hofmann, B. (2017). Is monetary policy less effective when interest rates are
persistently low? Conference Volume 2017, 59-87.
Manalo, J., Perera, D., & Rees, D. M. (2015). Exchange rate movements and the Australian
economy. Economic Modelling, 47, 53-62.