Monetary Policy Reflects Process

Question: Discuss about the Monetary Policy Reflects Process. Answer: Introduction: Monetary policy reflects the process through which monetary authority of a specific economy handle supply of money. For that reason, it often target an interest rate and inflation rate to maintain stability at the price level so that people trust in the currency remains at the desired level. Many studies have highlighted monetary policy generally contribute to economic satiability and growth (Schularick and Taylor 2012). It helps economy to lower the unemployment rate and also help to maintain specific standard of exchange rate with other currencies. In this essay, the focus will be on the process by which monetary policy has been utilized in the Australian market. Historically, monetary policy has been considered as a powerful tool that has the capacity of heightening the floating exchange rate. For that reason, Australias monetary policy involves the effective management of the short-term interest rate for the fulfillment of the domestic objective. Thus, monetary policy along with fiscal policy simply represent myriad of tools utilized to minimize long period of inflation, low wages and high unemployment in the economy. For that reason, Reserve Bank of Australia (RBA) has focused on developing specific monetary policies that can have major positive impact on the economic development perspective of the country. The policies initiated by RBA include interest rate setting on any particular overnight loans in the money market (rba.gov.au 2017). It creates impact on other interest rate that eventually affects the behavioral pattern of the lenders and borrowers in the financial market. The essay will try to highlight the kind of impact monetary policy has created in the Australian market over the past 2 to 3 years. The essay will also try to highlight the role of Australian government in the effective utilization of the monetary policy. It will also try to analyze whether monetary policy has able to fulfill all the prime objectives effectively or not. Objectives of monetary policy: As highlighted by Rey (2015) economies try to utilize monetary policy for fulfilling some specific objectives. Otherwise, the entire currency network in the economy might get affected in a major way. In Australia, Reserve Bank Act 1959 help to establish objectives of the monetary policy in a major way. The prime objective of initiating monetary policy is to maintain the currency stability in the Australian economy. It will ensure that all the economic activities can be fulfilled in an appropriate manner. Secondly, monetary policy in Australia also focuses on the effective utilization of the labor market. In fact, it focuses on maintaining zero unemployment policies so that people do not have to struggle to lead their life happily. Moreover, the monetary policy also focuses on enhancing the rate of overall economic welfare and prosperity within the Australian economy. Due to the influence of these objectives, monetary policy has achieved continues consumer price inflation of around 2 to 3 percent per annum (econotimes.com 2017). It has been assessed that monetary authority in Australia has deliberately tried to achieve this inflation rate to ensure Australian market can able to achieve sustainable growth. Thus, it articulated the fact that monetary policy in Australian economy is very much concerned about controlling the rate of inflation to maintain the value of money at the desired level. Hence, Australian monetary policy is very much focused towards the long-term growth of the economy. The monetary policy framework: As highlighted by Calza, Monacelli and Stracca (2013) monetary policy need to focus on controlling the rate of inflation in such a way so that value of currency could not able to deteriorate in a major way. Now, government of Australia, Treasurer and RBA has accepted the target of achieving inflation rate of around 2 to 3 percent per year. However, in order to achieve this low rate of inflation require effective decision-making system, which will anchor expected private inflation in an appropriate way. The above figure highlighted the fact that inflation rate in Australia has came down over the past few years. It also emphasizes on the inevitable uncertainties that are associated with the forecasting technique in the money market. For that reason, Baxa, Horvth and Va?ek (2013) have mentioned that inflation is extremely complex factor to fine tune with a short band. It also articulated the fact that monetary policy is actually dampening the fluctuations in amount of output produced within the course of the business cycle. It has influenced Australian government to focus on taking serious decisions based on the monetary perspective. Implementation strategy of monetary policy in the Australian market: As opined by Neely (2015) monetary policy in the developed countries like Australia focuses on the effective utilization of short term interest rate so that it can be controlled closely by RBA. The relevant rate of interest for Australia is termed as cash rate that reflects the market interest on the different types of overnight funds. For that reason, RBA tries to utilize close control over the cash rate through the money market operations and its applicability as the policy instrument. In fact, RBA has tried to justify its approach through the utilization of public statements. However, Corden (2012) have argued that focusing on short-term instrument might not provide required amount of support for the initiated policies. It has been assessed that cash rate has massive impact on the interest rate. As a result, it helps to set the short-term interest rate in the wider economy in an appropriate way. It can be applicable for financial intermediaries, key rate of banks and money market rates. For instance, business loans and mortgage rate tend move proportionality with any movement in the cash rate. As a result, it allows monetary policy for Australian market huge amount of power to create impact on the aggregate economy. In the pre-deregulation time, monetary policy utilized through a mixture of direct controls over the financial institutions and financial market operations. This includes the controls over the reserve equipments, bank interest rates and different types of other balance sheet restrictions. However, policy management style has gradually become ineffective in the Australian market, as several private and government functions have able to develop ways for avoiding regulations. As a result, it has created direct impact on the unregulated parts of the financial market. As per the article by Hofmann and Bogdanova (2012) monetary policy is easier and transparent to describe, as it is directly associated with the short-term interest rate. Domestic market department of the banks has the responsibility of maintaining condition of the money market so that it can ensure the cash rate remains near to the operating market. Now, cash rate reflects the rate charged for the overnight loans among the f inancial intermediaries. For that reason, monetary policy initiated in the Australian market has powerful influence on the other interest rate. The above figure shows the close relationship between other money market interest rates and cash rates. Now, RBA has focused on domestic market operations namely open market operations to maintain the cash rate near to the decided target. For that reason, RBA has focused on handling the supply of the available funds to the financial institutions in the money market. Lowe (2012) has highlighted the fact that demand and supply of overnight funds determine the cash rate in the money market. For that reason, it is crucial for all the financial institutions to maintain control over the supply of funds, which also help to settle transactions among themselves. In fact, it has been termed as exchange settlement funds. Now, it is necessary for RBA to utilize exchange settlement funds in such a way so that it can able to provide maximum impact over the monetary policies. For instance, if RBA provide more exchange settlement funds than commercial financial institutions wish to hold, it will def initely try to shed funds through the lending more in the money market. It has induced cash rate in the Australian market to fall significantly. On the other hand, if RBA provide lesser amount than financial institutions wish to hold, it will have to focus on borrowing more from the cash market. As a result, it will increase the present cash rate of the Australian economy. Impact of monetary policy in Australian economy: As highlighted by Benes et al. (2015) it is necessary for every economy to focus on continues evaluation process regarding the kind of impact monetary policy can have on the overall prosperity. However, it has to be kept in mind that monetary policy is very away from being completely mechanical in their operation. In fact, monetary policy makers will have to deal with the market related uncertainties at the time of developing economic forecasts. For that reason, monetary policy makers try to utilize best available information to ensure that the developed strategy can actually able to create desired impact on the Australian economy. As highlighted by Bordo and Landon-Lane (2013) short-term interest rate can have major impact on the aggregate demand and associated activities. From the above figure, it can be assessed that substantial changes in the rate of interest help to contain inflationary boom. It has created adverse impact on the overall demand in the Australian economy. With respond to the inflationary pressure and cyclical development, monetary policy has created major impact on the economic activity and powerful demand. For instance, higher rate of interest enhances the cost associated with the borrowing for financial expenditure. For that reason, monetary policy focuses increasing the incentive rate to delay or save the spending. Moreover, it also focuses on net reduction for returns to investments. For instance, in case of purchasing a house by a particular household can be delayed or stopped through the increasing mortgage rate. As people have to spend more for purchasing house, they will not try to buy house at that point of time, which will increase the cash on hand for the Australian people. It highlights the fact that, majority of the hous eholds has relatively smaller budget for purchasing house. Therefore, increase in the interest payment will reduce the capacity of the people. This can be explained through the following figure: The above figure highlighted the fact that higher mortgage rate is associated with the reduced amount of investment in the Australian market. The figure also has highlighted the fact that, mortgage rate at the time of early 90s is extremely high in Australia. For that reason, it has seen very limited process in the housing and construction sector at that point of time. However, with time Australian monetary policy makers has focused on the significance of housing activity on the overall financial performances. For that reason, they have consciously tried to reduce the mortgage rate consistently. During the period of 2013 to 2016, mortgage rate in Australia is extremely low, which has helped the entire construction sector to grow in an immense manner. As a result, huge number of recruitment has been done in the Australian construction sector for the past five years that is likely to grow in future as well. On the other hand Kashyap and Stein (2012) have highlighted the process through which monetary policy affects the cash flow channel of the economy. It has been assessed that majority of the households has focused on taking advantage of financial arrangements to borrow from the economy in an effective manner. For that reason, household sector of Australia considered as net borrowers. As a result, they are net payers of interest as well. In Australia, households with debt will feel that their interest payment is much higher in comparison with their own income that can be indicated by the net payments of data. Prime reason for this is net amount hides much larger amount for payments and interest receipts of several population groups. In fact, it has induced younger generation of Australia to borrow large amount at the early stage to finance several aspects, which will gradually become net asset in their later life. It highlights the fact that changes in the interest amount can have majo r impact on the cash flows on different population groups. Conversely, impact of change in interest rate is completely different for debtors and creditors. An increase in the interest rate minimizes the cash flow for debtors while it increases for creditors. Moreover, debtors are regarded as more sensitive with any changes in the cash flow, as they have limited financial assets to maintain their spending pattern (Somasundaram 2017). Thus, increase in the interest rate reduces the spending pattern of the household. Now, monetary policy in Australian market tends to maintain interest rate consistent, so that peoples spending pattern remains unaffected as much as possible. Bjrnland and Halvorsen (2014) have highlighted the fact that monetary policy can also have major impact on the money and credit perspective of the economy. It has been assessed that tightening the strength of monetary policy create more complex situation for borrowers to take loans. As a result, it has direct impact on the spending pattern of the borrowers. Now, Australian financial system is heavily regulated, which has increased the significance of quantity mechanism in the operation of monetary policy. Therefore, monetary policy affected the Australian economy through the execution of loans. A strict monetary policy will reduce lending pattern of the banks. From the above figure, it can be assessed that credit growth is positively correlated with the GDP growth of the economy. The figure has also highlighted the fact that nominal GDP in Australian market has seen a steady growth during the period from 1990 to 2006. However, nominal GDP has dropped significantly in the Australian market that has also affected the credit growth rate of the economy. During the period of deregulation, financial institutions have increased their lending to such an extent that contributed to the economic boom in the Australian market. It has also increases the price level of the existing asset. However, the impact has taken a reverse turn when economic cycle broke down. Thus, it establishes the fact that money and credit does play a critical role in the effectiveness of the implemented monetary policy. Moreover, it also has highlighted the fact that money supply has remained consistent over the past few years, as money supply remain at the optimum level. Howe ver, many studies have mentioned that money supply cannot be controlled entirely. Therefore, it needs to change on the basis of selected objective. Now, as mentioned earlier, Australian economy is focusing on maintaining the inflation rate very low. Therefore, it has become necessary for the monetary policy makers to contain the amount of money supplied in the market. As per the article by Gal and Gambetti (2015), monetary policy can also have major impact on the exchange rate of the economy. Now, exchange rate fluctuations can affect the entire economy by changing the relative prices of foreign and domestically produced goods and services. Therefore, fluctuation in the exchange rate creates direct impact on the domestic spending proportions. Now, exchange rate in Australian economy has been fluctuating for the past few years, which also has major impact on the behavioral pattern of the economy. For instance, it has affected the overall economic activity of the country, as it focusing on importing products that are more expensive. On the other hand, it is looking export relatively cheaper products, which will increase depreciation associated with the exchange rate. As a result, it has created an expansionary impact on the Australian economy at an aggregate level. As highlighted by Coats and Khatkhate (2014) exchange rate is another significant cha nnel by which monetary policys impact transmitted to the entire economy. It has been assessed that an increase in domestic interest rate, which has increased the importance of equity flow in the Australian market. Koukoulas (2017) have mentioned the fact that monetary policy indirectly affects the inflation rate of the economy. It has been assessed that demand above the productive capacity of an economy creates inflation in the market. It allows employees or labor to charge higher prices that has direct impact on the cost required for fulfilling all the activities of the operational process. As a result, it has influenced policy makers to focus on the effective utilization of monetary policy so that inflation rate remains under control. For that reason, inflationary pressures have been developed by a surge in growth as the speed of recovery from recession increases at the time of 2007 to 2008. However, it has not increased the inflation in the Australian market for that particular timeframe. Thus, it highlights the fact that Australian monetary policy has been conducted in a forward-looking fashion. The policy makers have raised the interest rate in the middle of 90s to mitigate the affect of inflationary pressures. On the other hand, they have minimized the interest rate when the pressures related to inflation have eased. Conclusion: The above discussion has highlighted the fact that monetary policy can have major impact on the overall economical condition of a particular economy. It can actually help economies to maintain the inflation rate at the desired level. In fact, if other factors remain constant, monetary policy can actually help to dictate inflation pattern of the economy. For instance, the study has highlighted the fact that Australian authority has consciously focused on controlling the amount of money supplied to economy so that it cannot able to create unexpected inflationary impact on the market. Moreover, the essay has also highlighted the fact that effective utilization of monetary policy can also have major impact on the aggregate demand of the economy. It also can influence the import export behavior of a particular economy, which can have major impact on the exchange rate as well. References: Anzuini, A., Lombardi, M.J. and Pagano, P., 2012. 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