monetary policy

Question 1

what is monetary policy?

Answer 1

those actions taken by the Reserve Bank of Australia to affect monetary and financial conditions in the economy by affecting the price of money and credit

Question 2

what does monetary policy involve?

Answer 2

setting the interest rate on overnight loans in the money market (cash rate)

Question 3

what is the aim of monetary policy?

Answer 3

aim of MP is to help achieve sustainable growth in the long run by controlling inflation

Question 4

what are the objectives of the reserve bank?

Answer 4

the sustainability of the currency (price stability or low inflation)
the maintenance of full employment (low unemployment); and
the economy prosperity and welfare of the people

Question 5

what are the effects of high inflation?

Answer 5

increases uncertainty
redistributes income
encourages investment in non-productive assets
erode value of savings
undermine value of currency
decrease international competitiveness
often associated with high unemployment and a stagnant economy
higher interest rates which prevent private sector spending and lowers economic growth

Question 6

what are the benefits of low inflation?

Answer 6

maintains the real value of money
protects the value of savings
keeps nominal interest rates low
promotes productive investment
reduces uncertainty which promotes long term growth
promotes international competitiveness
improves decision making

Question 7

what is the financial sector?

Answer 7

the intermediary between savers and investors

Question 8

what are the types of financial markets?

Answer 8

loan, bond, share

Question 9

what are interest rates?

Answer 9

represent the price of credit - a payment from borrowers to lenders for the use of funds

Question 10

what is the cash rate?

Answer 10

cost of overnight loans and is the main tool which the RBA uses to affect the monetary and financial conditions in the economy. The cash rate affects the interest rates which is a key instrument in either slowing down or increasing domestic investment

Question 11

what will the rba do to the cash rate in an upswing/boom?

Answer 11

enter the money market to create a shortage of cash
increase the price of cash (the cash rate)
will cause other interest rates to rise
higher interest rates means that the price of borrowing money rises then the demand for credit will contract and private sector spending in the economy will fall
contractionary/tight monetary policy stance

Question 12

what will the rba do to the cash rate in a trough/recession?

Answer 12

create surplus of cash which will reduce the cash rate
place downward presser on interest rates charged on loans by banks and other financial institutions
cost of borrowing will fall, the demand for credit will rise
spending and economic activity will increase
expansionary/easy monetary policy

Question 13

when will the rba raise the cash rate?

Answer 13

the economy is growing too fast (EG > 4%)
actual GDP is above potential GDP
unemployment is below the natural rate (UE > 5%)
inflation is above the target range ( I > 3%)
the economy is hit by a positive aggregate demand shock

Question 14

when will the rba lower the cash rate?

Answer 14

the economy is growing below the long run average rate of growth (EG < 3%)
actual GDP is below potential GDP
unemployment is above the natural rate (UE > 5%)
inflation is below the target range (I < 2%)
the economy is hit by a negative aggregate demand shock

Question 15

what is neutral monetary policy stance?

Answer 15

consistent with the cash rate being around 4%

Question 16

what is expansionary monetary policy?

Answer 16

RBA will adopt an expansionary stance when the economy is hit by a negative aggregate demand shock causing real GDP to contract, the price level to fall and the unemployment rate to rise

Question 17

what is contractionary monetary policy?

Answer 17

RBA will adopt contractionary monetary policy stance when the economy is in a boom

Question 18

what affect will lower interest rates have?

Answer 18

encourage both households and firms to increase their borrowing to help increase spending
cause the AUD to depreciate due to reduce foreign investment and capital cash flow
this will help to raise net exports
AE will rise in the economy which will help to boost the economy’s growth rate
real GDP and economic activity will expand
price levels will rise, inflation rises

Question 19

what affect will higher interest rates have?

Answer 19

discourage households and firms from increasing their borrowing and help reduce their spending
will attract capital inflow, increasing the demand for the AUD and causing AUD to appreciate
this will reduce net exports
AE will fall as consumption, investment and net exports fall
real GDP and economic activity will contract

Question 20

what are the strengths?

Answer 20

flexible
greater political neutrality
effective in a boom
more effective with a free exchange rate

Question 21

what are the weaknesses?

Answer 21

less effective during a recession
suffers from time lags
affects everyone in the economy
more effective when employed to slow the economy than it is to stimulate it.

Question 22

what has been the contemporary monetary policy?

Answer 22

monetary policy stance over the past three years (2014-206) has been expansionary
economy recovering from the end of the mining boom and collapse of the ToT