“c04AggregateDemandPoliciesAndDomesticEconomicStability_PrintPDF” — 2022/6/7 — 8:31 — page 366 — #80
• Using a looser (more expansionary or accommodating) monetary policy during a recessionary downswing:
U
N
CO RR EC
TE
D
PA
G
E
PR O
O
FS
The RBA’s monetary policy stance is eased/loosened/becomes more expansionary to stimulate AD when inflation is below the 2–3 per cent target, and GDP growth and employment are weak (e.g. 2020 and 2021, during and following the COVID-19 pandemic). There are several steps involved: • The RBA announces the cut in the cash rate target and justifies its decision by referring to its checklist of indicators. • Following the announcement of a cut in the cash rate target, this automatically shifts the policy interest rate corridor vertically downwards to a level that extends either side of the new lower cash rate target. Close compliance to the new lower cash rate is assured by the RBA, given its ability to legally set deposit and lending rates in the short-term money market (STMM): • On the one hand, there is the new lower unattractive deposit rate (normally set at 0.25 percentage points below the cash rate, although currently it is set at just 0.10 percentage points below the cash rate target to avoid negative interest rates) for banks with excess cash in exchange settlement accountsthis provides guidance and an incentive for banks to lend their excess cash to other banks at a higher interest rate that is closer to the new cash rate target. • On the other hand, the new RBA lending rate to banks with a shortfall of cash is normally set at 0.25 percentage points above the cash rate- this causes banks that are short of cash to borrow from other banks at a lower rate closer to the new cash rate target. • Once in place, the RBA may then have to conduct open market operations (OMO) involving the buying or selling of government bonds designed to change the supply of cash and offset any tendency for a drift in the cash rate caused by changes in the demand for cash in the STMM. • Finally, with the lower cash rate target, various transmission mechanisms kick in to boost AD and economic activity. • Using a tighter (less expansionary) monetary policy during an inflationary upswing: The RBA’s monetary policy stance is usually tightened/made more contractionary to slow AD when inflation approaches or starts to exceed the 2–3 per cent inflation target. This tightening process occurs through several steps: • Following the RBA Board’s announcement of a rise in the cash rate target, this automatically shifts the whole policy interest rate corridor vertically upwards to a new level spanning either side of the higher cash rate target. Close compliance to the new higher cash rate is assured because the RBA controls its deposit and lending rates: • On the one hand, there is the unattractive deposit rate offered by the RBA (normally set at 0.25 percentage points below the cash rate but currently set at 0.10 percentage points below the cash rate target) for banks with excess cash — this provides guidance or an incentive for banks to lend their excess cash to other banks at a higher interest rate closer to the new cash rate target. • On the other hand, the new RBA lending rate to banks short of cash is normally set at 0.25 percentage points above the cash rate, causing banks that are short of cash to borrow from other banks at a lower rate closer to the new cash rate target. • Once in place, the RBA may then have to conduct daily open market operations involving the buying or selling of government bonds. These operations change the supply of cash to offset any tendency for a drift in the cash rate caused by changes in the demand for cash in the STMM. • Finally, with the higher cash rate target that flows through to increased interest rates elsewhere in financial markets, various transmission mechanisms kick in to slow AD and economic activity to sustainable levels. • Transmission mechanisms are used to help bring about a rise or fall in the level of AD and economic activity, following a change in the cash rate target, so as to achieve domestic economic stability and improve living standards. • Following a cut in the cash rate during a slowdown, various transmission mechanisms help stimulate AD and economic activity. Lower interest rates cause a rise in the demand for credit to finance C and I, lead to an increase in the supply of credit by banks, boost the cash flow available for household spending, add to a feeling of being wealthier and weaken the exchange. Together these channels strengthen AD, economic growth and employment, improving our general living standards.
366
Key Concepts VCE Economics 2 Units 3 & 4 Eleventh Edition
