lecture8_week8_mae203+t1+2016+psb

7/26/2019 Lecture8_week8_MAE203+T1+2016+psb

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Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

MAE203, T1, 2016

Lecture 8, week 8

Topic 5

Monetary System and Monetary o!icy

Chapters 11 and 12


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"#apter 11

Monetary System

oney, -an.s andthe /eserve -an. ofAustralia

so+*hai&huttersto*.


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Learnin$ o%&ecti'es

1 3efine +oney and dis*uss its fun*tions

2 3is*uss the definitions of the +oney supply used inAustralia today

% 4plain ho6 finan*ial institutions *reate +oney

# 3is*uss the role of the /eserve -an. of Australia

5 7vervie6 the 8uantity theory of +oney and use it toeplain ho6 high rates of inflation *an o**ur

%


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(urma)s peop!e turn to $o!d *orsa'in$s

9f a *ountry:s govern+ent *reates too +u*h +oney, this *an leadto very high rates of inflation and e*ono+i* *ollapse ;he rapidinflation in -ur+a (


5/86Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

Money+Assets that people are generally 6illing toa**ept in e*hange for goods and servi*es or forpay+ent of dets

Asset+Anything of value o6ned y a person or fir+

#at is money and w#y do weneed it-

5

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-arter and the invention of +oney

Barter is thee*hange of goods or servi*es for othergoods or servi*es

-arter re8uires a double coincidence of wants.

"ommodity money+A good used as +oney thatalso has value independent of its use as +oney

oney +a.es e*hange easier therey allo6ing forspe*ialisation and higher produ*tivity

$

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@hat is +oney and 6hy do 6eneed it


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Money in a or!d ar prisoner o* war camp

3uring @orld @ar 99*igarettes 6ere used

as +oney in so+eprisoner of 6ar*a+ps

!

Makin$the

"onnection 111

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;he fun*tions of +oney

1 ediu+ of e*hange

2


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@hat *an serve as +oney ;here are five *riteria that +a.e a good suitale

to use as a +ediu+ of e*hange

1 ;he good +ust e acceptable to +ost people2 9t should e of a standardised quality.

% 9t should e durable.

# 9t should e valuable relative to its 6eight sothat it *an e easily transported

5 9t should e divisible.

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@hat *an serve as +oney *ontCommodity money+eets the *riteria for a +ediu+of e*hange, ut has the prole+ that its valuedepends on its 8uality

eg gold is a +ediu+ of e*hange ut its valuedepends on its purity

iat moneyB oney, su*h as paper *urren*y, that isauthorised y a *entral an. or govern+ent ody and

that does not have to e e*hanged y the *entralan. for gold or so+e other *o++odity +oney

10

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"urrency+otes and *oins held y the privatenonDan. se*tor

M1+;he narro6est definition of the +oney supply6hi*h is *o+prised of *urren*y plus the value of allde+and deposits 6ith an.s

4ow do we measure money today-

11

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emand deposits+Also *alled *urrent deposits,these are deposits in finan*ial institutions that aretransferale y *he8ue, y deit *ards at 4E;P7ter+inals and through ele*troni* transfer et6een

a**ounts

;hey are *alled de+and deposits e*ause they areavailale on de+and, and are repayale in notes

and *oins

12

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'o6 do 6e +easure +oney today

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-roader definitions of +oney

M3+1, plus all other deposits of the private nonDan. se*tor 6ith do+esti* and foreignDo6ned an.s

operating in Australia

9n*ludes *ertifi*ates of deposit, ter+ deposits anddeposits 6ith an.s fro+ uilding so*ieties, *reditunions and other authorised depositDta.ing

institutions

1%

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-roader definitions of +oney, *ont

(road Money+%, plus deposits into nonDan.depositDta.ing institutions +inus holdings of

*urren*y and deposits of nonDan. depository*orporations

onDan. depository *orporations in*lude finan*e*o+panies, +oney +ar.et *orporations and *ash

+anage+ent trusts

1#

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i h l li h i


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our*eB Created fro+ /eserve -an. of Australia (201#), Monetary Aggregates, ;ale 30% at F666ragovau, vie6ed 1$ ay 201#

15

Measuring the money supply, Australia, March 2014: Figure 11.1


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Credit

"redit+Loans, advan*es and ills provided to theprivate nonDan. se*tor (individuals and fir+s) y allfinan*ial inter+ediaries

Credit is not a for+ of +oney, ut is no6 used ythe /eserve -an. of Australia (/-A) as a +ain+easure of +onetary +ove+ents in Australia

1$


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Credit, *ont

Australia, ar*h 201#B ;otal *redit 6asH22%! illion

;otal *redit *o+prisedB

76nerDo**upier housing loansB H05 illion

9nvest+ent housing loansB H##51 illion

7ther personal loansB H1#1" illion, of 6hi*h *redit*ards *o+prised H#" illion

-usiness loansB H!#$ illion1!


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-an. alan*e sheets.eser'es+3eposits that a an. .eeps as *ash in itsvault or on deposit 6ith the /eserve -an. ofAustralia

Reserve ratio (RR)B A an.:s ratio of reserves todeposits

Ecess reservesB /eserves aove the nor+al ratio of

reserves to deposits

A loan is an asset to a an. and a depositis aliabilityto a an.

1"

4ow do *inancia! institutionscreate money-

Balance sheet for Save !" Ban#: Figure 11 2


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Assets 7 mi!!ionsLia%i!ities and s#are#o!ders)

e9uity 7 mi!!ions

/eserves 50 000 3eposits %00 000

Loans 2#0 000 hortDter+ orro6ing $0 000

3eposits 6ith other an.s 5 000 LongDter+ det 50 000

e*urities 100 0007ther liailities #0

000

-uildings and e8uip+ent 5 000 Tota! !ia%i!ities :50 000

7ther assets 110 000 hareholders: e8uity $0 000

Tota! assets 510 000 Tota! !ia%i!ities and

s#are#o!ders) e9uity 510 000

1

Balance sheet for Save!" Ban#: Figure 11.2

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(ankncrease in demand accountdeposits

aveD9; H1000

;hrifty 00 (J 0 H1000)

;hird -an. "10 (J 0 H00)

Eourth -an. !2 (J 0 H"10)

;otal *hange inde+and a**ountdeposits

H10 000

25

$sing " accounts to sho% ho% a &an# can create money


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;he si+ple deposit +ultiplier

Simp!e deposit mu!tip!ierB ;he ratio of the a+ountof deposits *reated y an.s to the a+ount of ne6reserves

RR

1multiplierdepositSimple =

2$

'o6 do finan*ial institutions*reate +oney

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;he si+ple deposit +ultiplier versus the realD6orld deposit +ultiplier

;he realD6orld deposit +ultiplier is s+aller than the

si+ple deposit +ultiplier e*auseB

an.s +ay hold e*ess reserves

people do not deposit all their +oney'ouseholds and fir+s .eep roughly *onstant the

a+ount they hold in *urren*y relative to thevalue of their savings a**ount alan*es

2!

'o6 do finan*ial institutions*reate +oney

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;he /eserve -an. of Australia

.eser'e (ank o* Austra!ia .(AB ;he *entralan. of Australia

;he /-A has t6o +aor rolesB

1;o +aintain the finan*ial integrity and staility of theAustralian finan*ial syste+

2;o i+ple+ent +onetary poli*y

Monetary po!icy+;he a*tions ta.en y the /eserve-an. of Australia to +anage interest rates in thepursuit of +a*roe*ono+i* goals

2"

T#e .eser'e (ank o* Austra!ia

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'o6 the /-A +anages finan*ial li8uidity andinterest rates

"as# rate+;he interest rate on loans in theovernight +oney +ar.et

;pen market operations ;M;sB ;he /-Apur*hasing or selling finan*ial instru+ents su*h asCo++on6ealth Govern+ent e*urities and privateonds and se*urities, either y outright pur*hase orsale, or y the use of repur*hase agree+ents

2


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'o6 the /-A +anages finan*ial li8uidity andinterest rates, *ont

.epurc#ase a$reementB ;he /-A offers to uy (orsell) Co++on6ealth Govern+ent e*urities and other

eligile finan*ial instru+ents fro+ an.s or otherauthorised finan*ial dealers, provided the sa+e an.sor dealers are prepared to repur*hase (or resell) the+at a future date, often in a fe6 days: ti+e, at a pri*e

agreed at the outset

%0


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'o6 the /-A +anages finan*ial li8uidity andinterest rates, *ont

;he +aority of /-A intervention in finan*ial +ar.etsis to sterilise, or offset, daily li8uidity defi*its and

surpluses, to .eep interest rates stale

;o c!ange interest rates, the /-A +ay not offset anovernight surplus or shortage of funds in the finan*ial

syste+, or the /-A +ay engage in 77s

%1


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h . f l


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4*hange rate +anage+ent

;he value of the Australian dollar is deter+ined ythe intera*tion of the de+and for and supply of theAustralian dollar in international *urren*y +ar.ets

'o6ever, the /-A very o**asionally intervenes yuying and&or selling Australian dollars

;he /-A also +anages Australia:s foreign *urren*y

and onds, and gold reserves

%2


T# tit t# *

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Conne*ting +oney and pri*esB ;he e8uation ofe*hange

;he *onne*tion et6een the 8uantity of +oney andthe pri*e level is epressed in the follo6ing e8uation,

for+alised y e*ono+ist 9rving Eisher

J +oney supplyK ? J velo*ity of +oney

P J pri*e levelK J real G3P

YxPVxM =

T#e 9uantity t#eory o* money

%%

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;h tit th f


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Conne*ting +oney and pri*esB ;he e8uation ofe*hange, *ont

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;h tit th f


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;he 8uantity theory eplanation of inflation

;he e8uation of e*hange is transfor+ed toB

Gro6th rate of +oney supply M gro6th rate of velo*ity

J gro6th rate of the pri*e level (or inflation rate) Mgro6th rate of real G3P (or e*ono+i* gro6th rate)

@hi*h *an e rearranged asB

9nflation rate J gro6th rate of +oney supply M gro6thrate of velo*ity e*ono+i* gro6th rate

;he 8uantity theory of +oney

%5

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;h tit th f


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;he 8uantity theory eplanation of inflation, *ont

9rving Eisher 6as in*orre*t in stating that "is*onstant

Nuantity theory of +oney predi*tions do not hold truefro+ year to year

'o6ever, in the !on$ run, the 8uantity theoryprovides useful insightsB

9nflation results fro+ the +oney supply gro6ing ata faster rate than the e*ono+i* gro6th rate

Correlation and *ausation


%$

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'igh rates of inflation

#yperinflationis *aused y *entral an.sin*reasing the +oney supply at a rate far in e*essof the e*ono+i* gro6th rate

Govern+ents in so+e developing *ountries *anhave diffi*ulty in selling onds to the puli* to fundudget defi*its, so they for*e their *entral an.s touy the ondsOthis *an e very inflationary

Ger+any (122 D 12%), ;ur.ey (1 200$),i+a6e (200# 200")


%!

T#e erman #yperin*!ationMakin$


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T#e erman #yperin*!ationo* t#e ear!y 1=20s

3uring the postD@@9hyperinflation of the120s, people in

Ger+any used paper*urren*y to light theirstoves

Makin$the

"onnection 113

%"

"oca>"o!a dries up as t#eMakin$


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p?im%a%we currency no !on$erser'es as money

People in Afri*a uy +orethan %$ illion ottles of

Co*aDCola a year 9n 200",

i+a6e ran out of lo*ally

produ*ed Co.e for the first

ti+e in at least #0 years

-e*ause they *ould not

otain


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An Australasian *urren*y

#0

An inside !ook

;here *ould e*onsiderale advantagesto having a single*urren*y *o++on toAustralia and e6

ealandOut opponentspoint to the la*. of theaility to *ontrol do+esti*+onetary poli*y andtherefore interest rates

and inflation


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"#apter 12

Monetary o!icy

Po6erPoint to a**o+panyB

so+*hai&huttersto*.

Learnin$ o%&ecti'es


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Learnin$ o%&ecti'es

1 3efine +onetary poli*y and des*rie the +ain goals of+onetary poli*y in Australia

2 3es*rie ho6 the /eserve -an. of Australia affe*tsinterest rates

%


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nterest rates a**ect #ouse prices

#%

'o+e uyers are a+ong thehardest hit 6hen the /-A

in*reases interest rates ;heeight su**essive interest raterises et6een 2005 and 200"*aused average +ortgagerepay+ents to rise

signifi*antly, redu*ing ho+epur*hase affordaility andleading to a fall in housepri*es in so+e areas

3uring the e*ono+i* *ontra*tion that follo6ed the gloal finan*ial*risis, interest rates 6ere lo6ered and re+ained at histori*al lo6sin 201# ;his in*reased the de+and for +ortgages and housing,pushing up house pri*es and redu*ing affordaility

#at is monetary po!icy-LEA.//7->4C;9?4 1


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#at is monetary po!icy-

Monetary po!icy+ ;he a*tions ta.en y the /eserve-an. of Australia to +anage interest rates in thepursuit of +a*roe*ono+i* goals

;he goals of +onetary poli*y

1 Eull e+ploy+ent of the laour for*e

2 taility of the Australian *urren*y

% 4*ono+i* prosperity and 6elfare for the people of

Australia

##

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@hat is +onetary poli*y


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;he goals of +onetary poli*y, *ont in*e 1% the /eserve -an. of Australia (/-A) has

fo*used +onetary poli*y +ainly on a*hieving pri*estaility

n*!ation tar$etin$+ Condu*ting +onetary poli*y soas to *o++it the *entral an. to a*hieving a puli*lyannoun*ed level of inflation

;he /-A:s target inflation rate is et6een 2I and%I per annu+, on average over the usiness *y*le

#5

@hat is +onetary poli*y

"he rate of inflation, Australia 'actual an( tren() 1**+ 2014: Figure 12.1


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Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&eour*eB /eserve -an. of Australia (201#), Measures of consumer price inflation, ;ale G01, at F666ragovau, vie6ed 1" ay 201#

2014: Figure 12.1

#$ Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

T#e demand *or and supp!y o*LEA.//7->4C;9?4 2


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pp ymoney

;he de+and for +oney

;he +oney de+and *urve is do6n6ard sloping tosho6 the inverse relationship et6een the interestrate on finan*ial assets and the 8uantity of +oneyde+anded

;he interest rate on finan*ial assets is theopportunity *ost of holding +oney

Lo6 interest rates redu*e the opportunity *ost of

holding +oney 'igh interest rates in*rease the opportunity *ost of

holding +oney

#!

"he (eman( for money: Figure 12.2


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Interestrate, i

Quantity of money, M(billions of dollars)

0 $250

!

Money demand, M"

#!

00

1% &de'rease inte interestrate

2% 'auses anin'rease in te

*uantity of moneydemanded%

#"


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;he de+and for and supply of


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hifts in the +oney de+and *urve Changes in variales other than the interest rate

*ause the +oney de+and *urve to shift

;he t6o +ost i+portant variales that shift the+oney de+and *urve areB

1 /eal G3P

2 ;he pri*e level

#

pp y+oney

Shifts in the (eman( for money: Figure 12.+


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Interestrate, i

Quantity of money, M(billions of dollars)

0

M"1

& de'rease inreal +" ora de'rease inte pri'ele-el .ill sift

moneydemand tote left%

&n in'rease in real

+" or anin'rease in te

pri'e le-el .ill siftmoney demand to

te ri/t%

M"2

M"

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'o6 the /-A +anages the supply of *ash

/e*all fro+ Chapter 11B ;he /-A uses open +ar.etoperations to sterilise li8uidity *hanges in thefinan*ial syste+, in order to .eep the interest rate

the sa+e

;pen market operations ;M;s+ ;he /-Apur*hasing or selling finan*ial instru+ents su*h asCo++on6ealth Govern+ent e*urities and private

onds and se*urities, either y outright pur*hase orsale, or y the use of repur*hase agree+ents

51

+oney


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;pen market operations

52

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'o6 the /-A +anages the supply of *ash, *ont

/epur*hase agree+ents are 6idely used y the /-Ain its 77s

"as# rate+ ;he interest rate on loans in theovernight +oney +ar.et

;he *ash rate is deter+ined y the intera*tion ofde+and for and supply of funds in the overnight+oney +ar.et

5%

+oney

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'o6 the /-A +anages the supply of *ash, *ont ;he +aority of /-A intervention in finan*ial +ar.ets

is to sterilise, or offset, daily li8uidity defi*its andsurpluses, to .eep interest rates stale

;o c!ange the *ash rate, the /-A +ay not offset anovernight surplus or shortage of funds in the finan*ialsyste+, or the /-A +ay engage in 77s to *reate ashortage or surplus of funds

A *hange in the *ash rate typi*ally flo6s through thefinan*ial syste+ i+pa*ting all interest rates

5#

+oney

Shortterm interest rates, Australia, 1*-201+: Figure 12.4


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our*eB /eserve -an. of Australia (201#),About Monetary $olicy, Graph 2 at F666ragov au, vie6ed 2# >anuary 201# /eserve -an. of Australia,20012010 All rights reserved

55 Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

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E@c#an$e sett!ement accounts ESAs+ A**ountsheld 6ith the /-A y an.s and other finan*ialinstitutions to enale the overnight transfer of funds(*ash) et6een finan*ial institutions, and et6een the/-A and finan*ial institutions

4A:s enale realDti+e gross settle+ent (/;G) throughthe /-A infor+ation and transfer syste+ (/9;)

-alan*es held in 4As are *alled ec!ange settlementfunds.

5$

+oney

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;he de+and for and supply of+one


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;o redu*e the *ash rate, the /-A puli*ly announ*esthat it intends to do so

;he /-A 6ill then eitherB

not sterilise an overnight surplus, or

offer to uy a*. repur*hase agree+ents, or +a.eoutright pur*hases of onds

@hen the /-A pays for the onds, this in*reases*ash reserves held y finan*ial institutions and therate of interest 6ill fall

5!

+oney

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;he de+and for and supply of+oney


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;o increasethe *ash rate, the /-A puli*lyannoun*es that it intends to do so

;he /-A 6ill then eitherB

not sterilise an overnight shortage, or

use reverse repur*hase agree+ents or *arry out theoutright sale of onds

@hen the /-A re*eives pay+ent for the onds, thisredu*es *ash reserves held y finan*ial institutionsand the rate of interest 6ill rise

5"

+oney

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48uiliriu+ in the +oney +ar.et ;he /-A 6ill use +onetary poli*y to .eep interest

rates at its target rate

;herefore the +oney supply *urve is a !ori%ontalline at t!e current interest rate

5

+oney

!nterest rate targeting: Figure 12.A


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Interest rate(per 'ent per

year)

Quantity of money(billions of dollars)

0 $00

!

M"

Moneysupply, MS

$0


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48uiliriu+ in the +oney +ar.et, *ont

9n the 1!0s and 1"0s, the /-A used to use+onetary targeting

Monetary tar$etin$B Condu*ting +onetary poli*y

to *ontrol the siQe and rate of gro6th of the +oneysupply

;herefore the +oney supply 6as eogenouslydeter+ined y the /-A, and the +oney supply *urve

6as therefore verti*al ;he /-A no longer uses +onetary targeting, and

instead uses interest rate targeting$1

+oney

M

Monetary targeting: Figure 12.B


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Interest rate(per 'ent per

year)

Quantity of money(billions of dollars)

0 $00

!

M"

Moneysupply, MS1 MS2

50

#!

1% en teR& in'reases

te moneysupply from MS1

to MS22% te

e*uilibriuminterest

rate falls%

$2


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A tale of t6o interest rates

;he loanale funds +odel (see Chapter 5) is*on*erned 6ith the long&term real rate of interest

9n the +oney +ar.et +odel, the fo*us is on thes!ort&term nominal rate of interest

@hen *ondu*ting +onetary poli*y, it is the shortDter+ no+inal interest rate that is +ost affe*ted yin*reases and de*reases in li8uidity

7ften (ut not al6ays) there is a *lose *onne*tionet6een +ove+ents in the shortDter+ no+inalinterest rate and the longDter+ real interest rate

$%

+oney

Monetary po!icy and economicacti'ity

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acti'ity

'o6 interest rates affe*t aggregate de+and

Changes in interest rates 6ill not affe*t govern+entpur*hases, ut they 6ill affe*t the other three*o+ponents of aggregate de+andB

1 Consu+ption

2 9nvest+ent

% et eports

$#

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onetary poli*y and e*ono+i*a*tivity


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;he effe*ts of +onetary poli*y on real G3P and thepri*e level

7ver ti+e, potential G3P in*reases and the L/A*urve shifts to the right

;he fa*tors shifting the L/A also shift the /A *urveto the right, as fir+s 6ill no6 e supplying +ore goodsand servi*es

3uring +ost years, aggregate de+and also in*reases,and the *urve shifts to the right

$5

a*tivity

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;he effe*ts of +onetary poli*y on real G3P and thepri*e level, *ont

o+eti+es, aggregate de+and +ay not in*reaseenough to .eep the e*ono+y at potential G3P

Epansionary monetary policy +ay e used duringperiods of e*ono+i* *ontra*tion or re*ession

;he /-A +ay use epansionary +onetary poli*y to

in*rease aggregate de+and y +ore than it 6ouldhave in*reased 6ithout poli*y

$$

a*tivity

LEA.//7->4C;9?4 %



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E@pansionary monetary po!icy+ ;he use of+onetary poli*y y the /-A to de*rease interest rates

to in*rease real G3P

;he /-A de*reases the *ash rate

;his de*rease typi*ally flo6s through to de*reases in

interest rates through the entire e*ono+y

$!

a*tivity

LEA.//7->4C;9?4 %



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Lo6er interest rates +ay en*ourage invest+ent,in*rease net eports, and +ay in*rease *onsu+er

spending /eal G3P and the pri*e level 6ill rise

;he dyna+i* aggregate de+and and aggregate supply+odel is used to illustrate epansionary +onetarypoli*y

$"

a*tivity

ri'e le-el3R&S14pansionary 3R&S2

/pansionary monetary policy: Figure 12.


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Real +" (billionsof dollars)

0 $1000

100

SR&S1

&"1

1

&"2(.itout

poli'y)

&

SR&S2

4pansionarymonetarypoli'y 'auseste &" 'ur-eto sift furterto te ri/t%

105

2

102

1100

10 6

&"2(.it poli'y)

$ Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

Too !ow *or ero+ A cas# rate o*a!most ero in t#e Bnited States

Makin$the

"onnection 12 1


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;he Eederal /eserve in the


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Can the /-A eli+inate *ontra*tions and re*essions

Reeping a *ontra*tion or re*ession +ilder than it 6ouldother6ise have een is usually the est the /-A *an do

;here +ay e a recognition laga delay efore the/-A re*ognises that a *ontra*tion is i++inent

;he longest ti+e lag 6ith +onetary poli*y is theimpact lagthe ti+e ta.en for +onetary poli*y to affe*t

real G3P

!1

y

LEA.//7->4C;9?4 %



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4C;9?4 %



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74/86



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Real +" (billionsof dollars)

0 0

100

SR&S1

&"1

&"2(.it poli'y)

&

6

SR&S2

1000

10

100

107

&"2(.itout po

Contractionary

monetary policy

causes the ADcurve to shift to

the right by less

than it would

have without

policy.

Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e!5

LEA.//7->4C;9?4 %



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9s +onetary poli*y al6ays effe*tive and fair

;i+e lags +ay redu*e the aility of +onetary poli*yto i+pa*t on the e*ono+y at the appropriate ti+e

7ver the past t6o de*ades the /-A has largely eensu**essful in anti*ipating inflation and understanding the

lags

As an.s and finan*ial institutions are not required topass on *ash rate *hanges, the effe*tiveness of+onetary poli*y *an e redu*ed

9n re*ent years, an.s in Australia have not al6ayspassed on to *usto+ers the full a+ount of an interestrate redu*tion

!$

LEA.//7->4C;9?4 %



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9s +onetary poli*y al6ays effe*tive and fair *ont

onetary poli*y is +ore effe*tive at redu*ing the rateof inflation during an e*ono+i* oo+ than it is atsti+ulating aggregate de+and during a *ontra*tionor re*ession

-usinesses 6ill e un6illing to orro6 if thee*ono+i* outloo. is not good

-an.s +ay also e relu*tant to +a.e loans, as

o**urred in so+e *ountries follo6ing the 200!D200"gloal finan*ial *risis

!!

LEA.//7->4C;9?4 %



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9s +onetary poli*y al6ays effe*tive and fair *ont

onetary poli*y is a =lunt instru+ent: and does notaffe*t all people or industries e8ually

*it! contractionary monetary policyB

avers *an enefit and in*rease their spending -orro6ers (individuals and usinesses) fa*e higher

interest repay+ents on loans

Lo6 in*o+e earners are often =+arginal: orro6ers, and

+ay e at a higher ris. of loan defaults *it! epansionary monetary policy orro6ers enefit

+ore than savers!"

#y does t#e s#are market carea%out monetary po!icy-

Makin$the

"onnection 122


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"onnection 122

;he share +ar.etrea*ts 6hen the/-A i+ple+ents

poli*y to eitherraise or lo6erinterest rates

!

(a) &n epansionary poli'y Real +"

/pansionary an( contractionary monetary policy: Figure 12.-


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Reser-ean8 oardin'reases

te 'asrate

9terinterest

rates rise

In-estment,'onsumption

and net

eportsde'rease

:e &"'ur-e siftsto te ri/t

by less

tan itoter.ise

.ould a-e

Real +"and te

pri'e le-elrise by less

tan tey.ould a-e.itoutpoli'y

Reser-ean8 oardde'reaseste 'as

rate

( ) p y p y

(b) & 'ontra'tionary poli'y

9terinterestrates fall

In-estment,'onsumption

and neteportsin'rease

:e &"

'ur-e siftsto te ri/tby moretan it

oter.ise.ould a-e

and tepri'e le-el

rise bymoretantey .ould

a-e.itoutpoli'y

"0 Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) !"1#"$0102%%&'uard&a*roe*ono+i*s %&e

S#ou!d t#e .(A tar$et in*!ation-

Arguments in favour of inflation targeting+

LEA.//7->4C;9?4 #


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Arguments in favour of inflation targeting+

1 9n the long run there is no i+pa*t of +onetarypoli*y on potential G3P

2 'aving an epli*it inflation target +a.es it easierfor fir+s and households to for+ epe*tations of

future inflation, therey i+proving planning andeffi*ien*y

% onetary poli*y is less sue*t to a *hange ine+phasis, parti*ularly 6hen +e+ers of the/eserve -an. -oard *hange

# An inflation target provides a +easure of the /-A:sperfor+an*e

"1

A t i t i fl ti t ti

LEA.//7->4C;9?4 #

hould the /-A target inflation


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Arguments against inflation targeting+

1;he aility of the /-A to dire*tly pursue its othergoals is li+ited

2An inflation target poli*y assu+es that the /-A *ana**urately fore*ast future inflation rates, 6hi*h itdoes not al6ays do

%a.ing the /-A only a**ountale for inflationtargeting +ay +a.e it less a**ountale for its otherpoli*y goals, su*h as lo6 une+ploy+ent, e*ono+i*gro6th or e*hange rate +anage+ent

"2

4ow does t#e .(A measurein*!ation-

Makin$the

"onnection 123


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9t is very i+portant for the /-A to have an a**urate

understanding of the *urrent underlyingrate ofinflation 6hen it is i+ple+enting +onetary poli*y

"%

;herefore in addition toloo.ing at the CP9, the /-A

also uses other +easuresof *onsu+er inflation%

4*lusionDased +easures

;ri++ed +ean +easure

s t#e independence o* t#e .eser'e(ank o* Austra!ia a $ood idea-

LEA.//7->4C;9?4 5


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;he *ase for /-A independen*e

Avoids inflationary spending y the govern+ent ofthe day, 6hi*h +ay sell onds to the *entral an.

to finan*e e*essive spending

Avoids the use of +onetary poli*y to further otherpoliti*al goals Eor ea+ple, lo6ering interest ratesefore an ele*tion

"#

LEA.//7->4C;9?4 5

9s the independen*e of the /eserve-an. of Australia a good idea


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;he *ase against /-A independen*e

An independent *entral an. is not dire*tlya**ountale to voters, and +ay i+ple+ent

+onetary poli*y against the 6ishes of theele*torate

;oo +u*h e*ono+i* po6er +ay e *on*entrated inthe hands of a single or s+all group of nonDele*ted

peopleOthose on the /-A -oard

"5

An inside !ook;he -an. of 4ngland holds re*ord lo6 rates


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Eigure 1B ;he

lecture8_week8_mae203+t1+2016+psb

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