Economics Assignment: RBA Monetary Policy and Economic Impact

This economics assignment analyzes the Reserve Bank of Australia's (RBA) interest rate decisions, focusing on the factors influencing these decisions and their potential impacts. The assignment begins with an overview of the RBA's stance on future interest rate changes, supported by the latest RBA minutes. It then explores three key reasons behind the RBA's likely decision to increase interest rates, including global trends such as the Federal Reserve's actions, domestic economic growth, and improvements in the Australian economy. Furthermore, the assignment examines the implications of these interest rate changes for a specific client, considering the dual effects of increased borrowing costs and currency exchange rate fluctuations. It concludes that the overall impact on the client may be minimal due to an automatic hedge. The assignment draws upon macroeconomic principles and relevant references, offering a comprehensive analysis of the topic.

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Question 1
Based on the latest minutes of the RBA, it is apparent that the interest rates in the near future
would increase and would not remain constant. This is quite evident from the commentary of
the RBA.
Question 2
The three reasons to support the above decision are as follows.
1) Major central banks globally are increasing the interest rates. This is particularly true for
Federal Reserve which is expected to continue on the rate hiking spree considering the robust
growth that is witnessed in the US economy. During the given year, the AUD has already
shed about 8% against the USD as highlighted in the commentary (RBA, 2018). Further,
increases in the interest rate by the Federal Reserve would put more pressure on the AUD and
may cause further depreciation of the currency which would need to be contained (Mankiw,
2014). In this regards, it would be necessary for the Reserve Bank of Australia to hike the
cash rate so that the falling currency may get some support.
2) On the domestic front, the economic growth has been quite robust especially in the first
half of 2018. Even though in the third quarter, the GDP growth has become tepid, it continues
to remain strong. Also, this is supported by other macroeconomic data such as falling
unemployment and increasing inflation which has currently achieved the lower end of the
targeted range. It is expected that once the inflation rate is at the middle of the recommended
range, the RBA would increase the cash rate (RBA, 2018).
3) The economic growth across major developed countries (barring the exception of EU and
Japan) has been quite strong. As a result, the exports of Australia are improving with
increased prices of ore and mining exports. With the various efforts being made by the
Chinese government, it is expected that in the near term the Chinese economy would be on
track. Considering that China is the largest trading partner of Australia, this would further the
economic growth and hence make a very strong case for cash rate hike (RBA, 2018).
Question 3
On one hand, the increase in cash rate would lead to higher cost of bank credit which would
have adverse impact on the financial performance of the company since the client has a
variable interest rate loan. The interest expense would have to be increased in the budgeted

financial statements (Mankiw, 2014). Another key aspect is the impact on the currency
exchange rate. With higher interest rate, it is expected that the AUD would appreciate slightly
and would be able to halt the continuous fall against a strong USD. This is because with
higher interest rates being offered, some foreign money would enter Australia to invest in
debt funds which would enhance the demand for AUD (Krugman and Wells, 2014).
It is likely that this aspect would be positive for the client considering that it is importer and
hence these would be cheaper which could lower the cost of goods sold and thereby expand
profit margins. Hence, there are two opposite effects for the client considering the
unfavourable interest movement coupled with favourable currency movement. Thus, the
interest rate increase would have minimal effect on the client owing to an automatic hedge
being present as explained above.

References
Krugman, P. and Wells, R. (2014) Macroeconomics. 3rd ed. London: Worth Publishers.
Mankiw, G. (2014) Principles of Macroeconomics. 6th ed. London: Cengage Learning.
RBA (2018) Minutes of the Monetary Policy Meeting of the Reserve Bank Board, [online]
Available at https://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/2018-10-
02.html [Assessed November 4, 2018]