Task description: In this task, you will build a case study based on the article: RBA official interest rate decision 4 December 2018, provided on page 3 of this task sheet (along with the link). Guiding questions, found on page 4 of this task sheet will help you structure your response when building the case. Do not forget to apply the DADA framework, using data and graphs to support your response. A marking rubric is posted on the Moodle site, which can help you understand what is required to reach your desired level of achievement. Note: You will have to do research for this assignment to find some secondary data, tables and graphs from the ABS and RBA websites related to GDP, unemployment, inflation, exchange rates, interest rates and their impact on consumption demand, commodity prices, business investment and the housing market.
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Important Background Reading Regarding RBA
RBA Monetary Policy Background Information http://www.rba.gov.au/
The RBA board meets 11 times a year (not in January) at the RBA in Martin Place, Sydney. Prior to the meeting, board members are provided with analysis of the economy and the financial markets by the RBA staff (prepared by the Economic Analysis Department). Among these analyses are the bank’s forecasts of future inflation, as well as the likely future path of economic growth overseas and domestically. RBA monetary policy decisions are based on these analyses as well as a range of other macroeconomic assumptions. In addition, scenarios are provided as to the likely macroeconomic outcomes if monetary policy was adjusted. The RBA meeting occurs on the first Tuesday of each month. After much discussion, a consensus decision is reached as to whether to leave interest rate unchanged or to adjust these rates. The instrument that RBA uses is the cash rate and, if an adjustment is decided, it will be to adjust the cash rate by 0.25 per cent, 0.50 per cent or 1 per cent. The most common adjustments are 0.25 per cent and 0.50 per cent. Since the last decade, the adjustment has been at 0.25 percent. With the unfolding of GFC, the RBA monetary policy response has been to cut the cash rate six times since September 2008 and cuts have been as large as one per cent. These cuts were designed to help Australia avoid the synchronised international recession, which hit all of the major economies in the 2008-2010 period. While making official interest rate decision RBA takes into account domestic and international macroeconomic factors (related to major trading partners) such as inflation unemployment, GDP growth rate, exchange rate, government debt, current account deficit, housing market, international trade mining and manufacturing sectors. 3 Once the decision is made, the RBA Governor announces its decision and, if a rate adjustment is made, banks will potentially make changes to their interest rates the following day. RBA also publishes the minutes of its Board meetings two weeks after each meeting and provides quarterly statement on the Monetary Policy. The RBA does not set this interest rate (as the commercial bank sets its mortgage rate), but it continuously influences the rate through its daily financial operations in the money markets. If the RBA buys Treasury notes, the supply of excess reserves in the banking system increases and the cash rate falls. If the RBA sells Treasury notes, the supply of excess reserves in the banking system decreases and the cash rate increases. Because of these changes in the cash rate, interest rates in general are influenced. In May 2015, RBA cut the official interest rate to 2.0 percent, which remained unchanged for a year. In May 2016, RBA governor announced a cut in cash rate by 0.25 basis point, to 1.75 percent, which remained unchanged until August 2016. The official cash rate since August 2016 has been at the historical low of 1.50 percent for 28 months until December 2018.
Media Release Statement by Philip Lowe, Governor: Monetary Policy Decision Date 4- December-2018 https://www.rba.gov.au/media-releases/2018/mr-18-31.html
At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.
The global economic expansion is continuing and unemployment rates in most advanced economies are low. There are, however, some signs of a slowdown in global trade, partly stemming from ongoing trade tensions. Growth in China has slowed a little, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector. Globally, inflation remains low, although it has increased due to the earlier lift in oil prices and faster wages growth. A further pick-up in core inflation is expected given the tight labour markets and, in the United States, the sizeable fiscal stimulus.
Financial conditions in the advanced economies remain expansionary but have tightened somewhat. Equity prices have declined and credit spreads have moved a little higher. There has also been a broad-based appreciation of the US dollar this year. In Australia, money-market interest rates have declined, after increasing earlier in the year. Standard variable mortgage rates are a little higher than a few months ago and the rates charged to new borrowers for housing are generally lower than for outstanding loans.
The Australian economy is performing well. The central scenario is for GDP growth to average around 3½ per cent over this year and next, before slowing in 2020 due to slower growth in exports of resources. Business conditions are positive and non-mining business investment is expected to increase. Higher levels of public infrastructure investment are also supporting the economy, as is growth in resource exports. One continuing source of uncertainty is the outlook for household consumption. Growth in household income remains low, debt levels are high and some asset prices have declined. The drought has led to difficult conditions in parts of the farm sector.
Australia's terms of trade have increased over the past couple of years and have been stronger than earlier expected. This has helped boost national income. Most commodity prices, however, have declined recently, with oil prices falling significantly. The Australian dollar remains within the range that it has been in over the past two years on a trade-weighted basis.
The outlook for the labour market remains positive. The unemployment rate is 5 per cent, the lowest in six years. With the economy expected to continue to grow above trend, a further reduction in the unemployment rate is likely. The vacancy rate is high and there are reports of skills shortages in some areas. The stronger labour market has led to some pick-up in wages growth, which is a welcome development. The improvement in the economy should see some further lift in wages growth over time, although this is still expected to be a gradual process
Inflation remains low and stable. Over the past year, CPI inflation was 1.9 per cent and in underlying terms, inflation was 1¾ per cent. Inflation is expected to pick up over the next couple of years, with the pick-up likely to be gradual. The central scenario is for inflation to be 2¼ per cent in 2019 and a bit higher in the following year.
Conditions in the Sydney and Melbourne housing markets have continued to ease and nationwide measures of rent inflation remain low. Credit conditions for some borrowers are tighter than they have been for some time, with some lenders having a reduced appetite to lend. The demand for credit by investors in the housing market has slowed noticeably as the dynamics of the housing market have changed. Growth in credit extended to owner-occupiers has eased to an annualised pace of 5–6 per cent. Mortgage rates remain low, with competition strongest for borrowers of high credit quality.
The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
Suggested structure and guiding questions for your case study
Introduction: Provide an introduction about the case.
Question 1: Explain the main objectives of monetary policy. List and describe the key functions of money and the Reserve Bank of Australia.
Question 2: Illustrate and explain using the money market equilibrium model and monetary transmission mechanism how an increase in the cash rate from 1.5% to 2% would help to keep inflation within the target rate, and how a further decrease from 1.5% to 1 % in the cash rate would help to stimulate the economy.
Question 3: Why does the RBA takes into account the domestic (Australian) and global (China, Japan, and USA) macroeconomic indicators (GDP growth rate, investment, household consumption, inflation, unemployment, and exchange rate) when making a decision whether to change (increase or decrease) or keep the official cash rate unchanged? Explain. In particular, discuss the effect on household consumption, business investment, GDP, inflation and housing market. Describe the circumstances in which the RBA Board might increase the cash rate.
Note: Use GDP, unemployment, inflation, and housing market statistics, which can be obtained from the Australian Bureau of Statistics and RBA websites for the last 5 years to see the trends and reasons, when answering this question.
Question 4: On 4-December-2018, the Governor of the RBA, Dr Philip Lowe, decided to leave the official cash rate unchanged at 1.50 percent as house prices continue to fall. Why did the RBA keep the cash rate unchanged for the last 28 months? Justify your answer with reasons and evidence. (Note: information found in detail monthly minutes of RBA) https://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/
Question 5: Define economic growth. What are the determinants of long-run economic growth? Is the historically low interest rate of 1.50 percent (from August 2016 until the now) sustainable to achieve long-run economic growth? Yes/No, justify your answer with reasons. Note: Students need to give their own views supported and justified by several references and examples.
Conclusion: Provide an overarching conclusion to the case.
Reference list: Use in text citations within your paper to refer to these references.
NOTE: Please check the marking rubric provided for the case study
The terms of trade in Australia has enhanced over the past two years and stronger as expected. This has enabled to boost the national income. Further, the Australia dollar remained under a range thereby signalling that the economy is performing well. The overall report rests upon the monetary policy, and the role played by the RBA. The report initiates with the introduction followed by the main functions of monetary policy and role performed by RBA. Further, the money market equilibrium is then discussed and progresses towards the discussion of the cash rate. Moreover, the debate spread to the unchanged cash rate. Lastly, economic growth is considered and defined.
The Reserve bank must ensure that the monetary policy is under control and the economy is devoid of undue pressure. The most important function is to attain the system of stability of price, full employment attainment of the economic prosperity. The RBA board meeting 11 times in a year and before the initiation of the meeting the board members are given the economic evaluation. The RBA monetary policy completely rests on such assessment. From the discussion, it is noted that the common adjustments undertaken are that of 0.25 percent. The cash rate of Australia stands at a historic low of 1.50 percent since 2016. In 2016, there was a cut in the cash rate by 0.25 basis point that remained unaltered till August 2016. From the case study, it is noted that the Board left the cash rate unchanged at 1.50 percent. This was because the economy of Australia is performing is a dangerous manner. Since the business condition is a positive and non-mining investment of business is expected to enhance. Hence, considering the overall factors the decision to leave the cash rate unchanged was justified.
1. Objectives of monetary policy Macroeconomics Case Study : Monetary policy can be defined as that mechanism that helps in ensuring an operation that is effective and pertains to the economic system or set of specific aims through the influence on the supply, cost, as well as money availability. By monetary policy, it can be said that conscious action is undertaken by the monetary authorities to alter the quantity, availability or money cost. The monetary policy in the developed economies, function as a stabilizer and helps in maintaining proper equilibrium. While in the case of underdeveloped countries, the monetary system is more pronounced that assists in meeting the need of the economy that is expanding that creates a proper condition for the progress of the economy. It is ascertained that monetary policy acts as a potent tool when it comes to the concept of transformation of the economy (RBA, 2018). The objectives of the monetary system are as follows:
The rapid growth of the economy – It can be defined as the main aim of the monetary policy. It enhances the growth of the economy by the control of the real interest rate and the impact on the investment. If the RBI considers a cheap or easy credit policy by lessening the interest rate, the investment level can be enhanced. The enhanced investment leads to acceleration of economic growth (Pennings et. al, 2015). Faster economic growth can be possible when the monetary policy maintains stability regarding income and price.
Stability of price - Economic scenario is prone to inflation, as well as deflation. It is even termed as price instability. Both increases prove to be a disadvantage to the economy as a whole. Therefore, the monetary policy has the sole motto to stabilize the prices in the economy and try to keep the value of money stable in nature (Pennings et. al, 2015).
Money can be ascertained and commented on having three major function that is the medium of exchange, store of value and the unit of account.
The medium of exchange - Money’s vital function is to enhance the transactions and hence, termed as a medium of exchange. It leads to the abolition of barter where ample difficulties were observed regarding exchange value. Money in an effective manner eliminates the double presence of want by acting as a medium of exchange and is accepted by every party irrespective of the desire of goods and services (Watson, 2018).
Money neutrality - The main aim of the money is to have neutrality in the economic scenario. It is of the opinion that the authority of money should direct towards money neutrality in the economy. Commercial alterations happen due to the presence of monetary change (RBA, 2018).
Stability of exchange- Monetary authority mainly resides on the exchange stability, and it needs to be noted that the instability in the rate of exchange can lead to significant issues resulting in the adverse balance of payments. Hence, stable transfer plays a vital role regarding international trade. A steady rate of exchange helps in maintaining international trade. Therefore, it is evident that the equilibrium needs to be kept in the country so that fluctuations or deviation does not happen.
It is the primary function of the Reserve Bank of Australia to ensure that the monetary, as well as banking policy, should be directed in a fashion that will help in stabilizing the currency of Australia, maintenance of full employment and the overall economic prosperity (Mankiw et. al, 2011).
Further, the Reserve Bank strives to promote the total stability of the financial system that aims to reduce the stake of the financial complexities that contains major effects and respond to the financial system disturbances. The bank has to work on such disturbances in collaboration with other agencies (Mankiw et. al, 2011). Further, the Reserve bank design produces, as well as issue banknotes with the primary objective of ensuring public confidence in notes that is considered as a significant payment scheme and ensures storage of wealth. Moreover, it even provides banking services of specialized nature to the government, as well as foreign official institutions. It contains payments, as well as collections and other forms of maintenance.
2. Money market equilibrium model: Transmission mechanism can be explained as that procedure by which decisions based on monetary policy can play a vital role in influencing the pricing level and economy on the whole. Further, transmission of monetary policy can be explained as to how any variation in the rate of cash can influence the business and household interest rates, inflation, and employment on the whole. Moreover, such transmission can assist the Reserve Bank in evaluating all future and present economic developments that also includes the establishment of effective monetary policies. Nevertheless, a central bank can play a vital part in the determination of interest rates at which the overall banking system attains resources.
This can affect the rate of deposits and lending together with variables like prices of assets and exchange rates. Further, the decisions on the Monetary Policy Macroeconomics Case Study also influence future inflation anticipations (Mankiw et. al, 2011). Overall, exchange rates, a rate of interests, prices of assets, etc. can pursue a powerful impact on decisions based on investment and saving, overall demand and supply, etc. Therefore, when the total demand is lesser than the global supply, there will be a declining impact on the prices and vice-versa. In general, such a transmission mechanism can be explained as a complicated web of several financial transactions wherein it is problematic to quantify the impact of decisions of monetary policy on the level of price and the overall economy. Nonetheless, considering the loopholes in the process of transmission, any variations in the monetary policy made today can affect the level of pricing after years or months.
The central banks must also be capable of ascertaining what policy stance is required in the current phase to sustain the stagnancy of prices in the upcoming tenure. Moreover, considering the complications prevalent in the process of transmission, there exists a considerable element of unpredictability revolving around the size and timing of adjustment exaggerated by variations in the approach of monetary policy (Dolamore, 2018). Nevertheless, in this context, an orientation of medium-term is attractive in the scenario as it can assist in safeguarding unnecessary and irrelevant volatility in the entire economy. Nonetheless, when there is a lessening of cash rate by the Reserve Bank, other standards of interest in the whole economy also decline. Besides, lesser rates of interest also encourage spending. Further, businesses also react in such a situation by enhancing their production so that it can result in an increment of overall employment and activity. Hence, if demand is high, prices can be boosted, thereby resulting in more inflation.
3. Factors that form part of the altering cash rate of the RBA : The role of RBA (Reserve Bank of Australia) is to make sure that the welfare and economic prosperity of people are maintained, and monetary policy can serve as a significant tool in controlling inflation and encourage factors like sustenance of overall Australian employment, stagnancy of Australian currency, and welfare of the entire country on a whole (Dolamore, 2018).
Besides, considering the amount of money being rotated throughout the country, the RBA may either hold, increase, or lessen the rate of cash based on basis points so that demand can be increased or national spending can be restrained. Nevertheless, the factors taken into due consideration in this regard is as follows:
About the Australian economy, the Reserve Bank may look at factors such as:
b. Global economic situation: The Reserve Bank must consider the efficacies of the overall international economy that includes how demand of consumers, international housing markets, and currencies have been progressing. Further, it would also take into consideration the power of countries like USA, China, and other European Countries for better evaluation (Sexton & Fortura, 2005).
4. Cash Rate unchanged : The cash rate was left unchanged by the Governor of the RBA for the last 28 months because an alteration in the interest rate affects interest on mortgage, savings and the overall health of the economy. The cash rate can be defined as the interest rate that the banks change every other on the overnight loans. Banks usually lend money to other banks every day so that daily cash needs can be managed (Bendel, 2017). As the loans are present for the shortest term it is defined as the overnight funds and the interest charged is the overnight rate. Further, the cash rate is said to be the interest rate on the lowest term, and this is considered as the benchmark rate.
The RBA kept the cash rate stagnant because it wanted to keep the demand growth in flourish mode and the rate of inflation was seen at 1.9%. As the terms of trade in Australia was in a promising manner and stronger than the earlier times, the national income boosted. Further, commodity prices reduced and the costs of oil fell majorly. Hence, the Australian dollar remained at a range over the past few years. The positive outlook of the market further ensured that the cash rate remains unchanged. Instead of this, the governor of the RBA decided to settle the price. As the economy was in a growing trend, therefore, it was likely that the rate of unemployment will be low. Considering the factors, it can be commented that the stronger labor market proved to be of significant benefit for the overall development (Bendel, 2017). The enhancement in the economy was the primary reason that the cash rate was left unchanged for the last 28 months. The cash rate is changed when the demand tends to be uncertain, and improvement is missing in the economy.
Further, it needs to be noted that the cash rate influences the likelihood of the business and household for the funding process. Overall, considering the position of the economy, it can be commented that the link between the exchange rate, inflation, as well as the cash rate is complicated. The cash rate is of pivotal importance when it comes to the consumer, as well as businesses as the cash rate movement can influence lending, as well as borrowing activities. Therefore, going by the position of the Australian economy, the inflation and other relevant factors the cash rate was left changed by the governor of the RBA.
5. Economic growth : Economic growth can be defined as an enhancement in the ability of an economy or country to produce goods and services when compared from one tenure to another. Such economic growth can be easily measurable in real or nominal terms, the former of which can be adjusted for inflation. Besides, it is also feasible to attain economic growth in the absence of an increased aggregate marginal productivity through additional higher rates of birth or immigration. Economic growth also has a ripple impact wherein by diversifying the entire economy; businesses can witness an increase in profits that means prices of stock rises as well (Mankiw & Taylor, 2011). Such companies can then raise funds to invest more, thereby paving a path for adding further jobs to the entire workforce.
Long-run growth can be explained as the sustained increment in the overall quantity of services and goods that is produced by an economy. The Gross Domestic Product (GDP) of an economy is also closely interconnected with the growth of such population together with supply, demand, and prices. The major determinants of long-term growth are as follows:
Conventional wisdom has held that lower interest rates can allow entrepreneurs to be motivated toward borrowing so that they can invest in new productive abilities, thereby accelerating higher growth. Further, when lower interest rates of 1.50% have been prevalent in an economy, it would make more sense for the capital owners to gear up and invest their resources in existing assets like financial instruments or property instead of risking their funds in unspecific new ventures. Nevertheless, even though the anticipated returns may not be as appealing as desirable by the owners, but such leverage can motivate them, and the pay-off is attracting as well (Braeutigam, 2010). Furthermore, based on the analysis of various economists, lower interest rates can assist in reigniting the overall housing market with investors surging back and capital gains increasing within the market. Such a lower interest rate can also help in tackling the risks of rising indebtedness level. Overall, long-term economic growth can be attained through such a lower interest rate.
From the overall discussion, it can be commented that the monetary policy of the country is an essential step towards the stabilization of the economy. It is one such action by the central bank that helps in macro-economic policy aims of low inflation and economic growth in a sustainable manner. The overall discussion relates to action taken by the Reserve bank of Australia in the financial market to attain the desired act of monetary policy. As Australia contains lower stance of inflation with labor market positive thereby, it is imperative that the monetary system was left unchanged.
Bendel, N. (2017) Why do banks change interest rates when the cash rate is steady? Available from: https://www.ratecity.com.au/home-loans/articles/banks-change-interest-rates-cash-rate-steady [Accessed 1 February 2019]
Braeutigam, R. (2010) Microeconomics (4th ed.). Wiley.
Dolamore, R. (2018) The tools of macroeconomic policy—a short primer. Available from: https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/Briefing Book44p/MacroeconomicPolicy
Mankiw N. Gregoryand, S & William M. (2011) Macroeconomics. Canadian ed., 4th ed. New York: Worth Publishers
Mankiw, N.G & Taylor, M.P. (2011) Economics (2nd ed) Andover: Cengage Learning
Mathai, K. (2012) monetary policy: stabilizing prices and output. International Monetary Fund. Available from:
Pennings, S, Ramayandi, A. & Hsiao, C.T. (2015). The impact of monetary policy on financial markets in small open economies: More or less effective during the global financial crisis. Journal of Macroeconomics, 44, 60-70. Available from: https://www.adb.org/sites/default/files/publication/28560/wp72-pennings-impact-monetary-policy.pdf [Accessed 1 February 2019]
RBA. (2018) The Implementation of Monetary Policy: Domestic Market Operations. Available from: https://www.rba.gov.au/mkt-operations/resources/implementation-mp.html [Accessed 1 February 2019]
Sexton, R & Fortura, P. (2005) Exploring Economics. Oxford university press
Watson, T. (2018) Mortgage rates rising, but no official cash rate change in store for May RBA meeting. Available from: https://mozo.com.au/home-loans/articles/mortgage-rates-rising-but-no-official-cash-rate-change-in-store-for-may-rba-meeting [Accessed 1 February 2019]