Australian monetary policy remains 'conventional'. The RBA adjusts the cash rate to influence interest rates throughout the economy. Those changes (although there have been none since 2013) work through the various monetary transmission mechanisms to affect Aggregate Demand (AD) and so inflation.
However when AD is very low and economic growth is really weak there is a limit to the amount conventional monetary policy can do. This occurs where interest rates approach zero. There are no more interest rate cuts possible to boost consumption and investment spending.
In the Eurozone the European Central Bank has set a cash rate of 0.05%. While some countries have set small negative rates (Switzerland for example) it is thought that changes at the rate at this level makes little difference to economic behaviour (Keynes talked of a liquidity trap at low interest rates which might be applicable here).
So the solution adopted in the US, the UK and Japan has been to print money to boost economic activity. This is called Quantitative Easing. The money is used to buy 'bonds' and this drives the price of those bonds up, meaning that they pay holders a lower real rate of interest. This helps by making borrowing cheaper in the economy and also boosting the money supply.
While some might worry about inflation when money is printed in this way they are missing the point. The aim is to inflate the economy, boosting AD and raising the level of economic activity leading to higher GDP and employment. The Eurozone badly needs this stimulus, as do all the countries that trade with Europe.
The BBC page explains the plan and how QE works. Why is this important for VCE? The same monetary transmission mechanisms work in Australia as work in Europe. It is essential you understand them for Unit 4.
Thursday 22 January 2015
Thursday 15 January 2015
Monetary policy in 2015
The role of the Reserve Bank of Australia (RBA) in monetary policy is to maintain the rate of inflation, on average, at 2% to 3% over the economic cycle.
The tool that the RBA has to achieve this is the interest rate (cash rate). They can adjust the cash rate to influence the level of Aggregate Demand in the economy. Lower interest rates encourage consumption, investment and exports (through a lower exchange rate). The higher the level of Aggregate Demand the greater is the upward pressure on inflation.
So the RBA monitors the level of economic activity in the economy (such as the rate of growth of GDP and other indicators of Aggregate Demand such as consumer spending) and attempts to set interest rates so that inflation meets its target.
The article below looks at the likelihood of an interest rate cut in Australia soon. This is based on low inflationary pressures particularly the fall in oil prices and the fall in the rate of activity in the construction industry.
There are many influences on the rate of inflation, often these influences conflict (a mixture of 'headwinds' and 'tailwinds'), but at present the overall effect seems to be for lower inflation. That demands an interest rate cut to encourage higher Aggregate Demand.
The tool that the RBA has to achieve this is the interest rate (cash rate). They can adjust the cash rate to influence the level of Aggregate Demand in the economy. Lower interest rates encourage consumption, investment and exports (through a lower exchange rate). The higher the level of Aggregate Demand the greater is the upward pressure on inflation.
So the RBA monitors the level of economic activity in the economy (such as the rate of growth of GDP and other indicators of Aggregate Demand such as consumer spending) and attempts to set interest rates so that inflation meets its target.
The article below looks at the likelihood of an interest rate cut in Australia soon. This is based on low inflationary pressures particularly the fall in oil prices and the fall in the rate of activity in the construction industry.
There are many influences on the rate of inflation, often these influences conflict (a mixture of 'headwinds' and 'tailwinds'), but at present the overall effect seems to be for lower inflation. That demands an interest rate cut to encourage higher Aggregate Demand.
The Guardian article is here
Greg Jericho's summary of important changes in the Australian economy in 2014 is below, which gives some wider context.
Monday 12 January 2015
Opportunity Cost - a choice always has to be made
The concept of opportunity cost is critical to understanding the basic economic problem. Because there is scarcity a choice has to be made on how to allocate scarce resources. The cost of that choice is 'the next best opportunity forgone' - the opportunity cost.
Britain's National Health Service (NHS) is a universal health service scheme, free at the point of use. It is comprehensive and includes dental, optical, physio etc. Very few Britons have or need private health insurance. (Around 11.7% of the population had private health insurance in 2010, with about half being provided this by their employer as part of a package. The figure for Australia is 54.7% in 2013.)
The NHS is therefore funded by the government from tax revenue. Of course it is very expensive and the NHS budget competes with all the other things government spends money on, such as pensions, defence and education.
The government must decide how much to spend on health. If the spend more on health they can spend less on education for example. Then the NHS must decide how to allocate their budget between uses. More on cancer treatments might mean less on hip-replacements for example.
The NHS is 'the envy of the world' according to many. However in the UK it is a constant struggle to fund it and illustrates the concept of opportunity cost every day. The attached article shows one example of opportunity cost.
Britain's National Health Service (NHS) is a universal health service scheme, free at the point of use. It is comprehensive and includes dental, optical, physio etc. Very few Britons have or need private health insurance. (Around 11.7% of the population had private health insurance in 2010, with about half being provided this by their employer as part of a package. The figure for Australia is 54.7% in 2013.)
The NHS is therefore funded by the government from tax revenue. Of course it is very expensive and the NHS budget competes with all the other things government spends money on, such as pensions, defence and education.
The government must decide how much to spend on health. If the spend more on health they can spend less on education for example. Then the NHS must decide how to allocate their budget between uses. More on cancer treatments might mean less on hip-replacements for example.
The NHS is 'the envy of the world' according to many. However in the UK it is a constant struggle to fund it and illustrates the concept of opportunity cost every day. The attached article shows one example of opportunity cost.
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