Strengths and Weaknesses of MP compared to BP Flashcards
List of Strengths of Using MP instead of BP to Affect AD
- No political bias / constraints
- Short implementation lag
- No financial constraints
Description of - No Political Bias - in terms of a Strength of MP
- As the RBA is not elected by the public and has no political affiliations, they make decisions purely based on economic factors (not political factors)
- This gives them the freedom to make economically sound but politically unpopular decisions.
List of Weaknesses of Using MP instead of BP
- Long impact lag
- Is blunt
- Creates asset bubbles and high household debt
Description of - Short Implementation Lag - in terms of a Strength of MP
- The RBA meets up every month to make a decision about the cash rate target.
- This gives them the flexibility to ‘wait-and-see’
- They can wait for key economic data before making decisions because they meet 11 times a year + (potential extraordinary meetings)
Description of - No financial constraints - in terms of a Strength of MP
- Unlike budgetary policy, the RBA does not have financial constraints.
- It can purchase as many bonds or change the CRT without limitations, as necessary, in order to meet the domestic macroeconomic goals.
Description of - Long impact lag - in terms of a Weakness of MP
‘Monetary policy has long and variable (impact) lags’
It takes time for changes in the cash rate target to make its way through the transmission mechanisms and into the economy.
- Some households have fixed mortgage rates (eg. they are not immediately impacted)
- Savings buffer
Statistics:
- only 40% of IR change will be felt after 12 months
- with 80% felt after two years and
- 100% after three years.
This lag means there’s a greater chance that MP could become pro-cyclical.
Description of - MP being Blunt - in terms of a Weakness of MP
Changes in interest by the RBA affect the overall levels of savings, consumption, investment, and net exports.
Because the economic impacts of the policy are so wide-spread, the policy can not precisely target particular areas of concern.
Description of - Creating asset bubbles and high household debt - in terms of a Weakness of MP
There is a strong correlation between interest rates and asset prices. Prior to this tightening cycle, the RBA cut interest rates over a 10-year period which drove share and house price accumulation.
Asset ‘bubbles’ can be created in times of expansionary monetary policy. But these bubbles can burst.
((An asset bubble refers to a situation in which the prices of assets (like real estate, stocks, or commodities) increase rapidly to unsustainable levels driven by exuberant market behavior, rather than their underlying intrinsic value.))
