Examining Monetary Policy and Its Impact on Australia's Economy

This essay provides an overview of monetary policy in Australia, focusing on its role in maintaining economic stability and fostering growth. It discusses the tools used by the Reserve Bank of Australia (RBA), such as setting cash rates, open market operations, and reserve requirements, to control infl...Read More

Running head: MONETARY POLICY 1
Monetary Policy
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MONETARY POLICY 2
What is monetary policy?
The role of the reserve bank of Australia is to maintain a stable economic environment
within the country. The bank formulates monetary and fiscal policies aimed at maintaining
stability and fostering a stable financial system. Monetary policies consist of decisions and
actions that ensure that money supply in the economy match growth and price goals of the
government (Parliament of Australia, 2017). The major objective of monetary policies is the
maintenance of price stability by keeping inflation levels low and stable. These decisions
include setting interest rates of loans in the money market so the behavior of borrowers and
lenders is affected. Monetary policies are used in controlling levels of unemployment since the
objective of government is to achieve full employment within the country. Successful
implementation of monetary policies also enhance economic prosperity and welfare among
citizens.
Tools of Monetary policy
There exist many several tools that the Australian reserve bank can use in implementing
monetary policies in order to counter fluctuations in the financial market and influence levels
of inflation. These tools can be used in isolation or complimentarily with each other or even
with fiscal policies. Fiscal policies influence the level of taxes and government expenditure in
the country while trying to maintain a stable level of inflation. The reserve bank sets a cash
rate that controls lending rates and deposit rates in the country. The inflation target is also used
to hold inflation rates between 2 and 3 percent (Reserve Bank of Australia, 2018).

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Open market operations is a common strategy used by the reserve bank of Australia in
controlling inflation levels. It includes purchasing and selling of government securities which
have an effect of regulating money supply and loan conditions. When reserve bank purchases
securities from the open market, commercial banks reserves increase hence enhancing the
money available for them to lend and resultantly increasing money supply in the economy.
When inflation levels are high, the reserve bank might sell risk free government securities that
promise interest in future. This reduces the amount of money supply in the economy hence
reducing inflation. The major methods used by the reserve bank in fulfilling open market
operations are repurchase agreements (Repos), reverse repurchase agreements, term Auction
Deposits, and horizontal Repos. Repos involves sale of government securities to commercial
banks to reduce commercial bank deposits kept in the reserve bank. Reverse Repos occurs in
the opposite direction with reserve bank purchasing securities from the commercial banks.
The reserve bank can also control reserve requirements for commercial banks.
Commercial banks deposit a specified portion of their money with the reserve bank. This
amount known as the cash reserve ratio is used by the reserve bank in adjusting the amount of
money in circulation. Increasing the cash reserve ratio reduces money supply while reducing it
increases money supply in the economy (Tim & Gianni , 2017). The deposits are kept at the
reserve bank without interest. The reserve bank can also use discount window operations to
control the amount of money in circulation in the economy. It being the lender at last resort
offers loans to commercial banks at an interest rate greater than the reserve bank requirement.
The penal rate discourages commercial banks from unnecessarily borrowing funds from the
central bank instead of borrowing from the market.

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Effects of Monetary Policies
The effects of monetary policies on the Australian economy are significant. Atkin & La
Cava (2017) highlighted that, reduction of cash rate by the reserve bank makes interest rates to
fall and thus stimulating higher spending. Firms respond to this phenomenon by increasing
production which has an effect of increasing economic activity and employment. However, it
is worth noting that, a strong increase in demand might push prices up and resultantly raising
inflation levels. The Australian reserve bank also reported that, a reduction of the cash rate by
100 basis points raises gross domestic product. Also, the effect of changes in the cash rate
might lead to a significant effect on economic activity and inflation between one to two years
later.
Monetary policies have implications on the levels of unemployment in Australia. The
pattern of the Australian Phillips curve had flattened in 2017 (Central Bank of Australia, 2017).
The Philip curve theory states that unemployment is inversely proportional to inflation such
that deflationary monetary policies increases levels of unemployment while expansionary
monetary policies reduces unemployment. There was a decline in unemployment in 2017 when
reserve bank implemented deflationary monetary policies. Wages were also reported to have
increased during the period.
Increasing interest rates as a monetary policy in Australia might have an impact of
attracting foreign-direct investment by making domestic assets more attractive compared to
foreign assets. In 2015, Australian foreign-direct investment was reported to be at $735.5
billion an increase from the previous year (Department of Foreign Investment and Trade, 2016).

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The high foreign-direct investment majorly by American, Japanese, and United Kingdom
investors was associated to the stable business environment in the country. Stability in
economic environment resulted from stable inflation levels, stable political environment, and
cheaper investment loans.
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References
Central Bank of Australia, 2017. Labour and Monetary Policy. [Online]
Available at: https://www.rba.gov.au/speeches/2017/pdf/sp-gov-2017-07-26.pdf
[Accessed 4 October 2018].
Department of Foreign Investment and Trade, 2016. Trade and Investment at a Glance. [Online]
Available at: https://dfat.gov.au/about-us/publications/trade-investment/trade-at-a-glance/trade-
investment-at-a-glance-2016/Pages/foreign-direct-investment.aspx
[Accessed 4 October 2018].
Parliament of Australia, 2017. Publications. [Online]
Available at: https://www.aph.gov.au/binaries/library/pubs/rp/1994-95/95rp33.pdf
[Accessed 4 October 2018].
Reserve Bank of Australia, 2018. Monetary Policy. [Online]
Available at: https://www.rba.gov.au/monetary-policy/
[Accessed 4 October 2018].
Tim , A. & Gianni , L. C., 2017. Publications. [Online]
Available at: https://www.rba.gov.au/publications/bulletin/2017/sep/pdf/bu-0917-1-the-
transmission-of-monetary-policy-how-does-it-work.pdf
[Accessed 4 October 2018].