Economics for Business: Monetary Policy

(Source: Mywealth.commbank.com.au 2016)

The above analysis shows that the interest rate is falling from the year 2011. The main tool of monetary policy is the interest rate that greatly affects the monetary policy of the economy. The main objective is to control the money supply in the economy to stimulate growth, achieve high employment, increase GDP and maintain the inflation rate (Lowe 2012).

The other tools of the monetary policy that the reserve bank of Australia uses are the cash reserve rate. Cash reserve ratios are the certain percentage of money that commercial banks have to keep with central bank. High cash reserve rates means that the central bank wants to control the money supply and vice versa. Similarly statutory liquidity ratio is the reserves that commercial banks need to keep with central bank in form of gold. Open market operations are the ratio at which the government bonds and shares are sold to people by the central bank. If government wants to control money supply in economy then it will sell bonds in the market and if it wants to decrease the money supply bonds and shares will be purchased from people by government (Karadi and Gertler 2015).

According to the World Bank data banks liquid reserves to bank assets ratio was last measured at 1.06. The main component of monetary policy is interest rates.

Australia’s unemployment and inflation rate

Here it can be seen that changes in interest rate has its effect on the inflation rate and the unemployment rate as well. The unemployment rate rises as the interest rate falls and the inflation rate or the prices of the goods falls in the economy. The reason for the rise in the unemployment rate is the rise in the population and the fall in the money supply of the economy.  When the investment is low in the economy the unemployment rises. Fall in interest rate raises the price level in the economy because the investment rises so people charge high prices for their goods and services (Gali 2015).

Affects and problems on Australian economy

The main aim of the reserve bank of Australia is to set the cash rates or the interest rates at the level where the country can achieve full employment and maintain price stability. It also aims at maximizing the welfare of the economy and increase the economic prosperity of Australian people. It seeks to set the inflation target at 2-3 percent on an average. The interest rate has great effect on the inflation rate. The interest rate is set at such level so that the reserve bank can set the inflation target at 2-3 percent. The main tool is the cash rates are the rate at which the commercial institution transacts the money. The cash rates in Australia are largely influenced by the open market operation or ratios. Monetary policies are also used to manage the debt in the economy. Repo rate is the rate which the central bank lends money to commercial bank in case of any shortfall of money and reverse repo rate is the rate at which the central bank borrows money from commercial bank (Backus et al. 2013).

Changes in the monetary policy or the interest rate directly affect the value of Australian dollar.  In 2010 the interest rate charged by the central bank was 6.2 %. This means that the interest was high in the economy. High interest rates mean low investment and high savings. High interest rates also mean low inflation rate. Interest rates and inflation rate have negative relation.

In 2011 the interest rate was 1.5 % that is very low. Low interest rates means that the government wants to increase the money supply in the economy and want the prices to rise to achieve the economic growth. This is the expansionary monetary policy that the government follows (Plumb et al. 2013). 

In 2012 the interest rate was at 4.8 %. This means that the interest rate was neither too low and nor too high. The government wanted the economy to stabilize by stabilizing the price of the goods and services in the county.

In 2013 the interest rate again rose to 6.4 %. This means that the government or the central bank of Australia wanted the money supply in the economy to be lowered in order to decrease the inflation rate. When then inflation or the prices of goods in economy rises then the central bank increases the interest rate so that money supply in the economy falls.

The recent press release shows that the parliament wants to lower the interest rates or the cash rates to drop to 1.75 percent. The main reason to do this is to increase the prices of the goods and services in the economy (Downes et al. 2014).

Conclusion

The global economy of Australia is growing. Monetary policy is an important tool that the central bank of an economy uses to maintain the money supply and price stability in the economy. The main tool of monetary policy is interest rates. It is the rate that central bank or the banks charge to lend money. Open market operation greatly influences the cash rates in Australia. The main effect of interest rates is seen in the inflation rate. Interest rates largely affect the price level. The interest rate in Australian economy is fluctuating in nature. Currently the central bank plans to lower the interest rate to increase the price level or the inflation as interest rate and inflation rate have inverse relationship. The main aim of Australian government is to achieve the inflation target by using the monetary policy.

References

"How Do Interest Rate Changes Affect Me? | Mywealth Commonwealth Bank". Mywealth.commbank.com.au. N.p., 2016. Web. 25 May 2016.

"World Bank Group". World Bank Group. N.p., 2016. Web. 25 May 2016.

Backus, D.K., Gavazzoni, F., Telmer, C. and Zin, S.E., 2013. Monetary policy and the uncovered interest rate parity puzzle. Available at SSRN 1634825.

Bekaert, G., Hoerova, M. and Duca, M.L., 2013. Risk, uncertainty and monetary policy. Journal of Monetary Economics, 60(7), pp.771-788.

Downes, P., Hanslow, K. and Tulip, P., 2014. The effect of the mining boom on the Australian economy. Reserve Bank of Australia Research Discussion Paper, 8, pp.1-44.

Fenna, A., 2013. The economic policy agenda in Australia, 1962–2012.Australian Journal of Public Administration, 72(2), pp.89-102.

Galí, J., 2015. Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework and Its Applications. Princeton University Press.

Karadi, P. and Gertler, M., 2015. Monetary Policy Surprises, Credit Costs, and Economic Activity. In 2015 Meeting Papers (No. 447). Society for Economic Dynamics.

Lowe, P., 2012. The changing structure of the Australian economy and monetary policy. The Recent Economic Performance of the States 1 Trends in National Saving and Investment 9 The Distribution of Household Wealth in Australia: Evidence from the 2010 HILDA Survey 19 India’s Steel Industry 29, p.79.

Plumb, M., Kent, C. and Bishop, J., 2013. Implications for the Australian economy of strong growth in Asia. Economic Research Department, Reserve Bank of Australia.