• BEO2000 Financial Institutions & Monetary Theory
• Lecture 5: Monetary Policy Implementation
• Primary Source:
• Hubbard et al. 2016, Ch. 16, Essentials of Economics
• Learning Outcomes
• With respect to learning outcomes, you should be able to:
a. Explain how the Reserve Bank of Australia (RBA) influences the level of interest rates
in the economy;
b. Discuss the implementation of monetary policy by the RBA;
c. Explain the transmission mechanism of monetary policy;
d. Use graphs to show the effects of monetary policy on real GDP and the price level.
e. The RBA and Monetary Policy
• The RBA formulates and implements monetary policy.
a. Conducted in a transparent manner to reduce uncertainty.
• The main goal of monetary policy has been revised to focus on inflation.
a. Inflation target of 2–3 per cent, on average, over the medium term.
• At this target range:
a. Inflation preserves the value of money;
b. Encourages strong and sustainable growth in the economy over the longer term.
c. Inflation Targeting: Australian Inflation: 1950-2017
• Monetary Policy: Cash Rate
• Monetary policy decisions involve setting the cash rate
a. Cash rate is the interest rate on unsecured loans overnight loans between banks.
• The cash rate cannot be changed by transactions between financial institutions.
• Only transfers between the RBA and a bank can affect the cash rate.
a. A change in the cash rate indirectly influences the term structure of interest rates in
the whole economy.
• Short-term interest rates, Australia, 1985-2017
• Monetary Policy: Cash Rate
a. Cash rate determined by supply and demand of exchange settlement funds (ESF).
• ESF is the balances (i.e., cash) held in ESAs.
• RBA is able to influence ESF demand.
, • RBA can manipulate ESF supply since it is the monopoly supplier.
b. RBA requires banks to have their ESA in credit at ALL times.
c. Banks that leave excess funds in their account overnight are paid a below cash rate
interest.
d. Penalties are designed to encourage banks to borrow and lend to each other
overnight at the (more attractive) cash rate.
e. Target and Actual Cash Rates, Australia, 1992-2018
• Open Market Operations (OMOs)
How the RBA manages the supply of cash.
• To reduce the cash rate, the RBA publicly announces that it intends to do so.
• The RBA will then conduct an:
i. Outright purchase of Commonwealth government securities (increases ES funds).
ii. The RBA purchases the bonds from financial institutions (FIs), this increases the cash
reserves (ESF) held by FIs and subsequently the rate of interest will fall.
iii. The RBA can also:
iv. Offer to buy back repurchase agreements (increases ES funds).
v. Not sterilise an overnight surplus.
vi. Open Market Operations (OMOs)
How the RBA manages the supply of cash.
• To increase the cash rate, the RBA publicly announces that it intends to do so.
• The RBA will then conduct an:
i. Outright sale of Commonwealth government securities (decreases ES funds)
ii. FIs purchase the bonds from the RBA which reduces the cash reserves (ESF) held by
FIs and subsequently the rate of interest will rise.
iii. The RBA can also:
iv. RBA borrows cash from banks through reverse repurchase agreements.
v. Not sterilise an overnight shortage.
vi. Fractional Reserve Banking (i.e., reserve requirements)
SCENARIO: $1,000 in currency with no currency drain
• Fractional Reserve Banking (i.e., reserve requirements)
• Fractional Reserve Banking (i.e., reserve requirements)
• Commercial banks are required to hold a specific percentage of their deposits.
• Lecture 5: Monetary Policy Implementation
• Primary Source:
• Hubbard et al. 2016, Ch. 16, Essentials of Economics
• Learning Outcomes
• With respect to learning outcomes, you should be able to:
a. Explain how the Reserve Bank of Australia (RBA) influences the level of interest rates
in the economy;
b. Discuss the implementation of monetary policy by the RBA;
c. Explain the transmission mechanism of monetary policy;
d. Use graphs to show the effects of monetary policy on real GDP and the price level.
e. The RBA and Monetary Policy
• The RBA formulates and implements monetary policy.
a. Conducted in a transparent manner to reduce uncertainty.
• The main goal of monetary policy has been revised to focus on inflation.
a. Inflation target of 2–3 per cent, on average, over the medium term.
• At this target range:
a. Inflation preserves the value of money;
b. Encourages strong and sustainable growth in the economy over the longer term.
c. Inflation Targeting: Australian Inflation: 1950-2017
• Monetary Policy: Cash Rate
• Monetary policy decisions involve setting the cash rate
a. Cash rate is the interest rate on unsecured loans overnight loans between banks.
• The cash rate cannot be changed by transactions between financial institutions.
• Only transfers between the RBA and a bank can affect the cash rate.
a. A change in the cash rate indirectly influences the term structure of interest rates in
the whole economy.
• Short-term interest rates, Australia, 1985-2017
• Monetary Policy: Cash Rate
a. Cash rate determined by supply and demand of exchange settlement funds (ESF).
• ESF is the balances (i.e., cash) held in ESAs.
• RBA is able to influence ESF demand.
, • RBA can manipulate ESF supply since it is the monopoly supplier.
b. RBA requires banks to have their ESA in credit at ALL times.
c. Banks that leave excess funds in their account overnight are paid a below cash rate
interest.
d. Penalties are designed to encourage banks to borrow and lend to each other
overnight at the (more attractive) cash rate.
e. Target and Actual Cash Rates, Australia, 1992-2018
• Open Market Operations (OMOs)
How the RBA manages the supply of cash.
• To reduce the cash rate, the RBA publicly announces that it intends to do so.
• The RBA will then conduct an:
i. Outright purchase of Commonwealth government securities (increases ES funds).
ii. The RBA purchases the bonds from financial institutions (FIs), this increases the cash
reserves (ESF) held by FIs and subsequently the rate of interest will fall.
iii. The RBA can also:
iv. Offer to buy back repurchase agreements (increases ES funds).
v. Not sterilise an overnight surplus.
vi. Open Market Operations (OMOs)
How the RBA manages the supply of cash.
• To increase the cash rate, the RBA publicly announces that it intends to do so.
• The RBA will then conduct an:
i. Outright sale of Commonwealth government securities (decreases ES funds)
ii. FIs purchase the bonds from the RBA which reduces the cash reserves (ESF) held by
FIs and subsequently the rate of interest will rise.
iii. The RBA can also:
iv. RBA borrows cash from banks through reverse repurchase agreements.
v. Not sterilise an overnight shortage.
vi. Fractional Reserve Banking (i.e., reserve requirements)
SCENARIO: $1,000 in currency with no currency drain
• Fractional Reserve Banking (i.e., reserve requirements)
• Fractional Reserve Banking (i.e., reserve requirements)
• Commercial banks are required to hold a specific percentage of their deposits.
