Monetary policy refers to as the actions by the RBA to influence the cost and availability of credit in the economy. The RBA performs monetary policy in line with the RBA act 1959 which states it must maintain the stability of the currency of Australia, the maintenance of full employment in Australia and the economic prosperity and welfare of the people of Australia. In addition, as agreed upon between the RBA and the treasurer, since 1993 the RBA through monetary policy has targeted a medium-term inflation rate between the bands of 2-3%. As a segment of the macroeconomic mix, Monetary policy’s role, alongside fiscal policy is to impact aggregate demand and act in a countercyclical manner to the business cycle. MP is a moderately effective tool in achieving Australia’s economic objectives of growth, price stability and full employment due to its limitations including, its impact lag of 6-18 months and its lessened effectiveness in times of low confidence. However, the RBA have been largely successful in making the right decisions in regard to monetary policy, although at times, the policies limitations has meant reduced efficacy. This can be assessed through monetary policies success in managing positive shocks, limitation in creating growth in a slowdown and minute impact in responding to major negative shocks.
Monetary policy has had success in managing positive shocks in the Australia economy. This was evident in the resumption of exponential mining investment period in 2012, which saw China’s resumption of growth to 12%, thus increasing the demand for commodity exports and saw Australia’s terms of trade reach a high of 113. During this time the RBA tightened MP from 3% to 4%, to return to normal lending rates and stabilise growth. In theory, this will create a decrease in AD in the economy and thus slowed growth. Graph decreasing AD. This restricted growth to discourage borrowing and spending by increasing mortgage and other loan expenses and thus minimising disposable income. Additionally, this aimed to dampen the decrease in unemployment (5% in 2009 and 5% in 2012) caused by increase in employment in the mining sector and wage growth (3%), which had led to inflationary pressures. This was effective in managing price stability as it kept inflation for the period between 2-3% annually. However, this was offset by the immense rise in the AUD, to all-time highs of 1 USD in 2011, in turn reducing import prices and increasing export prices. A contributor to this appreciation was the tightening of MP as the higher interest rate made the AUD more attractive for investors and thus the increase in demand assisted in the appreciation. Despite the negative effects of the increased AUD (Increase unemployment and imports), it also served as a means to stabilise growth, which was 2% in 2011. The Rudd governments contractionary fiscal policy of a deficit of 4% in 2011 to 1% in 2012/13 acted in assisting monetary policy to restrict growth. Consequently, in tightening monetary policy in response to a positive shock, the Australian economy was able to manage price levels and growth at the cost of a major appreciation in the AUD.
The effectiveness of monetary policy in creating growth during a slowdown in Australia’s economy was limited. This is made apparent post 2012, characterised by China’s slowdown in growth 12% in 2011 to 6% in 2019, in which Australia shifted from accruing major growth in mining investment in an attempt to grow non-mining industries, due to the
slowdown in demand for mining investment. During this period, Monetary policy had a crucial role in impacting both internal and external economic objectives, its consistent loosening down to 1% in August 2016 (from 4% in 2010), served to stimulate growth in the economy. This led to a housing investment boom, which had monumental impacts in increasing demand to buy houses which increased C in AD and thus GDP. However, MP limitations became evident after 2016 as it faced high levels of pre-existing debt (180% of GDP in 2016). Thus, after 2016 even with the loosening of monetary policy, encouraging further borrowing and spending was ineffective, which is highlighted by the subdued growth of 2% during this period and low inflation rates of 1% in 2015 and 1% in 2016. Further, unemployment averaged 5% during this period with lower wage growth of 2% in 2016 occurring as a result. Glenn Stevens said, “We can’t expect MP to dial up the growth we need” as “there is no further room to loosen”. Moreover, during this time, fiscal policy acted procyclical in an act of ‘fiscal consolidation’ (-2% deficit in 2013 to balance in 2019), thus the governments influence, whilst still in a deficit (Taxes < Spending), actually was undermining and exhausting monetary policy due to the liberal governments contractionary budgets. Therefore, MP had partial success in achieving in achieving economic growth (2%) in a period of slowdown, however, saw inflation fall outside of the target band of 2- 3% for long periods of time as a result of Fiscal consolidation and high levels of pre-existing debt.
Finally, conventional monetary policy has had very little impact in times of adverse negative shocks, with unconventional MP providing partial assistance. This is made clear from 2020 until present, on top of the already subpar economic climate that trade tensions and bushfires had precipitated, the COVID-19 pandemic necessitated a major macroeconomic response. However, unlike the other shocks such as the GFC, where both components of macroeconomic policy were able to support the economy by stimulating C and I, the government’s strategy of fiscal consolidation (2012-2019), saw to exhaust monetary policy going into the pandemic, making its conventional aspect essentially ineffective. Thus, MP has faced this collapse without the necessary weapons to respond as there is little conventional space. With the RBA loosening the cash rate initially to 0% at an all-time low, then further loosening it to 0% to stimulate inflation and AD by trying to increase household consumption and business investment. However, as a result of the transmission mechanism of monetary policy, this proved ineffective. The transmission mechanism describes the 6–18- month process by which a change in the cash rate impacts AD. This elucidates that in times of growth, MP is effective in reducing AD, although in times of stagnation, this will have a lessened effect in speeding it up. Thus, they have had to turn to unconventional monetary policy. Being, the subsidiary component of monetary, in which the RBA implement strategies, that do not necessarily regard changing the cash rate in order to stimulate growth, notably, quantitative easing. This refers to the purchase of Commonwealth government bonds in the secondary market used to increase liquidity and target the yield of government bonds at 0%. Unconventional monetary policy became a significant component in Australia’s response to recent external shocks, “The RBA are clearly a new important player” (Su-Lin Ong Head of the interest rate at Capital Markets RBC), through quantitative easing ($47b in a month) and providing financial stability (lending $90b to banks) increasing consumer confidence by ensuring the stability of the banks. Despite the governments $270b dollars’ worth of stimulus measures, monetary policy has been exhausted as a means to instigate inflation as the inflation rate was -0% (June 2020),
P2: Rebal - Limited in creating growth - Apparent in post 2012 period China slowdown growth 12% in 2011 to 5% in 2019, Australia shifted from mining due to slowdown in demand and increase world price - MP crucial role in growth consistent loosening to 1% in 2011 from 4 in 2016 - Lead to housing boom stimulating C in AD - Mp limitations evident high levels of pre-existing debt (180% of GDP in 2016). - after 2016 loosening mp to stimulate spending ineffective highlighted by subdued growth of 2% and low inflation 1% 2015 1% 2016. - Further unemployment averaged 5%, low wage growth of 2% in 2016. - Glenn Stevens said, “We can’t expect MP to dial up the growth we need” as “there is no further room to loosen”. - Moreover, during this time fiscal consolidation, 2% deficit in 2013 to balance in 2010, undermining and exhausting monetary policy due to the liberal governments contractionary budgets. - Partial success however inflation fell out of 2-3% due to fiscal consolidation and pre- existing levels of debt
P3: Covid - Conventional little impact with unconventional providing assistance - Made evident in 2020, interrupted supply chains, low consumer confidence as a result of health crisis necessitated major macro response. - Unlike GFC, where both could stimulate growth, FC had exhausted MP making conventional ineffective. - Cash rate all time low 0%, then again to 0% to stimulate inflation and AD. - However MP’s transmission mechanism, made this ineffective. - Transmission mech being 6–18-month process by which change in cash rate alters AD. - This elucidates in times of growth MP good in slowing but but in stimulating - Had to turn to unconventional, the subsidiary to conventional in which RBA implement policy that do not alter cash rate to stimulate, notably quantitative easing. - QE: purchase of CGB in secondary market used to increase liquidity and target the yield of government bonds at 0%. - UMP became significant component of Aus response to covid, “The RBA are clearly a new important player” (Su-Lin Ong Head of the interest rate at Capital Markets RBC). - through quantitative easing ($47b in a month) and providing financial stability (lending $90b to banks) giving consumer confidence through bank stability. - Despite 270b stimulus measures, MP exhausted unable to promote inflation (-0% June 2020), out of the bracket, attributed to by 12% contraction in consumption (June 2020). - annual GDP growth of 2020 facing a contraction of 1%, as unemployment reached highs of 7% in July (from 5% in February).
