Lecture 4.2: Monetary Policy

Question 1

Goals of Monetary Policy

Answer 1

The RBA is the Australian monetary authority
1. Price Stability
2. Full employment maintenance
3. Financial stability (economic prosperity and welfare of the people of Australia)
Mainly a combination of 1 and 2

Question 2

Inflation target and the reasons for the target

Reasons are both economic and institutional

Answer 2

2-3% on average over time (allowing for variation over time)
Economic reasons:
* Inflation low enough to not distort decisions
* Provides an anchor for inflation expectations

Institutional reasons:
* Transperancy and accountability
* Provides criterion to evaluate monetary policy success or failure

Question 3

Natural rate hypothesis

Issue and solution

Answer 3

When actual unemployment is pushed way below the natural rate it will end up increasing inflation without further reducing unemployment.

As such, we should focus on reducing the natural rate unemployment to then lower unemployment.

Question 4

Quantity theory of money (monetary policy in the long-run) + its assumptions

Answer 4

The general price level of goods and services is proportional to the money supply in an economy.

Assumptions:
1. Long run monetary neutrality - real GDP is not influenced in the long-run
2. Velocity of money is constant
3. Money supply M(t) is controlled by the central bank

Question 5

Velocity of money

Explanaition and formula

Answer 5

The observation that a given amount of money can be used to execute multiple transactions per period.

V(t) = (P(t)xY(t))/M(t)

Question 6

Long-run inflation + growth

Given the assumptions of the quantity theory of money

Answer 6

P(t)* = (M(t)V)/Y(t)*
gp* = gm - gy* (since gv is zero by assumption)

Question 7

Issues with quantity theory

Answer 7

• Velovity is not constant - it changes due to technologies
• Mt is a broad measure of money supply but, the RBA controls it and therefore it does not necessarily have to be determined by this value

Question 8

Monetary policy in the short-run

What should we expect it to change?

Answer 8

The output gap and cyclical unemployment

Question 9

Implementation of monetary policy

Answer 9

RBA targets cash-rate in overnight unsecured interbank markets (ESAs) - this sets the RBA lending rate 0.5 points above the target and the RBA deposit rate 0.5 points below the target meaning that banks have no incentive to borrow at a rate higher than this or lend at a rate lower than this so, they will slowly increase/decrease their rates until they meet the target.

Question 10

Unconventional Monetary Policy

Answer 10

Monetary policy strategies that don’t revolve around the use of the cash-rate to influence the economy:
1. Negative interest rates - you are charged interest when storing money not the other way round - this encourages you to spend rather than save
2. Extended liquidity programs - program where the central banks have a ‘lender of last resot’ type facility whereby fundamentally sound institutions can borrow to ensure they do not go under
3. Asset purchases - the outright purchase of assets in an open market operation - through crediting ESA balances
4. Forward guidance - telling the market they are going to do something which then prompts that very action

Question 11

Problems with monetary policy

(1)

Answer 11

It is crude - increasing interest rates may decrease Y and decrease inflation however in the process unemployment will increase and people will losse their jobs
- this impact is also unequally distributed

Question 12

REVISE CONTEMPOTRARY MACRO POLICY DEBATES SUMMARY ONE NOTE WEEK 6

Answer 12

woop woop have so much fun with that xx