Victoria University Macroeconomics (PHPE 403) Policy Assessment

This report analyzes the impact of monetary stimulus on the New Zealand economy, focusing on the Reserve Bank of New Zealand's (RBNZ) reduction of the official cash rate. It examines the effects of monetary policy on interest rates, aggregate demand, and inflation, using the AD-AS model to illustrate these relationships. The report discusses the effects of heightened uncertainty and declining international trade on aggregate demand and short-run equilibrium, as well as the role of central banks in easing monetary policy. It concludes by exploring the relationship between low interest rates and low expected inflation, considering the Neo-Fisherian theory and the role of inflation expectations in wage negotiations. The report includes figures illustrating changes in demand, interest rates, and inflation, and it is thoroughly referenced using APA conventions.

1Running head: MACROECONOMICS (PHPE 403)
Macroeconomics (PHPE 403)- Option 2: Policy Assessment 2
Ruchi Bhardwaj
Student ID: 300488552
Victoria University of Wellington

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Macroeconomics (PHPE 403)- Option 2: Policy Assessment 2
1. Impact of Additional Monetary Stimulus on the Mentioned Situation
The Reserve bank Of New Zealand (RBNZ) has reduced the official cash rate to 1.5
per cent, which might prove to be immensely beneficial for the employment. There is
uncertainty with respect to the global economic scenario. According to the RBNZ, domestic
growth has slowed down to a certain extent (Rbnz, 2019). Moreover, markets have taken
action for cutting the needs of the banks. With respect to the study, the monetary policy helps
in lowering the interest rates and motivating the expansionary monetary policies. In addition,
monetary policy has dealt with the interest rates, which also entails the contractionary as well
as expansionary ones. These two types of policies have emphasized macroeconomic goals
such as inflation and unemployment. Furthermore, the monetary policy generally deals with
the interest rates and the accessible amount of the loanable funds, which affects the
components of the aggregate demand (Lumenlearning, n.d.).
On the other hand, contractionary monetary policy deals with greater interest rates
and reduced quantity of the funds. On a similar note, expansionary monetary policy mainly
deals with the lower interest rate and higher loanable funds, which emphasizes business
investment and borrowing for the other items. In addition, when the economy deals with the
recession and higher rates of unemployment, the output is found to be listed below the
potential GDP (European Central Bank, 2019). Moreover, the expansionary monetary policy
enhances the economy largely.

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Figure 1: Changes in the demand
This figure generally defines the situation in the aggregate demand. This mainly
shows the short-run going upwards, which is considered as the Keynesian aggregate supply
curve (SRAS). In the figure, it has been observed that the equilibrium occurred at point E0
and provides out of 600 during the recession (Opentextbc, n.d.). On the other hand,
expansionary monetary policy mainly focuses on reducing the interest rates, accelerates the
investment and the consumption spending. Thus, it can be stated that the aggregate demand
curve (AD0) will shift towards the right to AD1. It can further help in understanding the new
equilibrium, which occurs in relation to the potential GDP level (Opentextbc, n.d.).
Figure 2: Changes in the Interest Rate

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Similarly, if the economy is dealing with the quantity of the output with respect to the
potential GDP, the contractionary monetary policy can help in decreasing the pressures of
inflation in the arising price level. According to the figure, it has been observed that the
original demand curve will be shifted to the AD1 and the new equilibrium point can occur at
point 700 (Opentextbc, n.d.). Furthermore, it can be stated that if there is a loss in monetary
policy, then it will be dealing with the recession and can enhance the aggregate demand
which triggers inflation (Opentextbc, n.d.).
2. i. Aggregate Demand Curve and Short-Run Equilibrium
The statement, “Heightened uncertainty and declining international trade [which]
contributed to lower trading-partner growth” is true as the uncertain performances of the
international trade are found to be affecting demand and supply rates. International goods and
service have different prices across the world. This price is considered as the world price for
all with respect to the product and service. When the domestic producers are not able to
produce the product with respect to the market value, the producer cannot sustain in the
competitive market (Howell & Ballantine, 2019).
Figure 3: Changes in the Demand with Uncertainty

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If the domestic supplier is able to supply the products at a rate less than the world
price, they can sell their product worldwide at a faster pace. In that case, the supply of the
domestic product will increase effectively until the equilibrium point has been reached. On a
similar note, it has been observed that the world price is higher as compared to the domestic
price. Producers are continuously selling their products on the worldwide platform and it will
go on until the domestic price increases with context to the world price. Thus, the demand
will also decline. On the other hand, the country can be benefitted, as the producer surplus
has increased with respect to a higher price. However, it absorbs the loss of consumer
surplus. This is how the total surplus has been maximized in the world market scenario
(Thismatter, n.d.).
On a similar note, uncertainty has decreased the aggregate demand. With respect to
the rule of Taylor, the central bank generally leads to a fall in the interest rate due to the
unfavourable impact of uncertainty. Moreover, the equilibrium unemployment has been
increasing in nature and the inflation rate falls with a rise in the level of uncertainty. Thus, it
can be stated that heightened uncertainty raises the unemployment rate by reducing aggregate
demand. It also contributes to decreasing the demand along with the relative price of the
goods. Furthermore, aggregate demand amplifies the impacts of uncertainty with respect to
the macro-economic action (Leduc & Liu, 2015).
2.ii. Easing of Monetary Policy by Central Banks Internationally
The main role of the central banks is to enhance the monetary policy for achieving
price stability. This price stability comprises low and stable ranges of inflation. It also helps
in managing the economic up and downs to a large extent. Moreover, inflation has been
considered as the framework for monetary policy. On the other hand, the central bank has
introduced a new explicit inflation target in New Zealand. In addition, central banks are
found to be conducting their policies with respect to the supply of money. This kind of

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market operations deals with short-term interest rates, which partially influences the long-
term rates. In addition, the framework of the monetary policy has a greater emphasis on the
deflation rate, which is mainly related to the unconventional monetary policies. This
monetary policy has a more flexible exchange rate with respect to the foreign exchange
(Imf.org., 2019).
3. Historically Low-Interest Rates are “Consistent with Low Expected Inflation”
This is true that low-interest rates possess a certain level of consistency with a lower
rate of expected inflation. Basically, lower inflation provides economic stability to the
monetary policy of the country. It has also been observed that the government generally deals
with the inflation rate of 2% (SparkCharge Media, 2019). There exists a level of compromise
between the costs of inflation and even that of deflation. In addition, when inflation deals
with the lower rate, the company should be considered optimistic in nature. This leads to an
increase in the productive capacity in economic growth.
Figure 4: Changes in the Inflation with Interest Rate
Figure 4 above depicts that the aggregate supply has been inelastic in nature. Thus, it
is clear that any fall in the AD will lead to a decrease in the Real GDP rate. Therefore, the
global inflation rate is found to be lower because of the financial crisis (EconomicsHelp,

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2019). According to the Neo-Fisherian theory it can be stated that inflation is low because of
the lower interest rates, which explain the movements of the interest rates with respect to the
movements in the expected inflation. Furthermore, the central bank interest rate is the only
thing, which can help in restoring the long-run economic equilibrium. This equilibrium’s real
interest rate deals with the declining trend, with respect to the monetary policy (Demary &
Hüther, 2015).
Moreover, the statement “A useful starting point is consideration of the role of
inflation expectations in wage rate negotiations” as stated in the question clearly depicts the
fact that in inflation has a lot to do with the decisions made in relation with the negotiations
made with respect to the wage rates between the unions as well as the employers. The
formation of the wages depends on varied factors such as the tax wedge, the rate of
unemployment, the benefits associated with the same and the market shares among others.
Since all these factors are inter-related, it needs to be understood that the concept of inflation
actually starts with the wage negotiations of varied individuals (BIS, 1997).

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References
BIS. (1997). Monetary Policy and the Inflation Process. Conference Papers, 1-400.
Demary, M., & Hüther, M. (2015). When Low Interest Rates Cause Low Inflation. Retrieved
September 28, 2019, From https://archive.intereconomics.eu/year/2015/6/when-low-
interest-rates-cause-low-inflation/
EconomicsHelp. (2019). Low Inflation. Retrieved September 28, 2019, From
https://www.economicshelp.org/macroeconomics/low_inflation/
European Central Bank. (2019). The role of fiscal and monetary policies in the stabilisation
of the economic cycle. Retrieved September 28, 2019, From
https://www.ecb.europa.eu/press/key/date/2005/html/sp051114.en.html
Howell, T. R & Ballantine, D. (2019). Dumping: Still a Problem in International Trade.
Retrieved September 28, 2019, From https://www.nap.edu/read/5902/chapter/28
Imf.org. (2019). Monetary Policy and Central Banking. Retrieved September 28, 2019, From
https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-
and-Central-Banking
Leduc, S., & Liu, Z (2015). Uncertainty Shocks are Aggregate Demand Shocks. Federal
Reserve Bank of San Francisco, 1-32.
Lumenlearning. (n.d.). Monetary Policy and Aggregate Demand. Retrieved September 28,
2019, From https://courses.lumenlearning.com/wm-macroeconomics/chapter/610/
Opentextbc. (n.d.). Monetary Policy and Economic Outcomes. Retrieved September 28,
2019, From https://opentextbc.ca/principlesofeconomics/chapter/28-4-monetary-policy-
and-economic-outcomes/

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Rbnz. (2019). Official Cash Rate reduced to 1.5 percent. Retrieved September 28, 2019,
From https://www.rbnz.govt.nz/news/2019/05/official-cash-rate-reduced-to-1-5-percent
SparkCharge Media (2019). What Is Inflation Definition – Causes of Inflation Rate and How
to Fight the Effects. Retrieved September 28, 2019, From
https://www.moneycrashers.com/what-is-inflation-definition-causes-inflation-rate/
Thismatter. (n.d.). Economic Benefits of International Trade. Retrieved September 28, 2019,
From https://thismatter.com/economics/economic-benefits-of-international-trade.htm