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Concept of Monetary Policy

Economics (Year 12) - Monetary Policy

Christian Bien

What is it?

Monetary policy is where the indirect, counter-cyclical process that uses the Reserve Bank powers to change the cash rate to influence economic activity to achieve macroeconomic objectives.

Reserve Bank Act 1959

The powers of the Reserve Bank are given under the Reserve Bank Act 1959. The act defines the Reserve Bank's objectives are as follows:

  • 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.

What are Cash Rates?

Cash rates are the interest rate the RBA charges on overnight loans by Australian banks (e.g. ANZ, CommBank, NAB, Westpac). In theory, when the cash rate rises, the interest rates on financial products also rise, as the interest rate they are charged by the RBA also increases.

For a more in-depth explanation...

Every day, thousands of transactions are made into and out of Australian banks, everything from grocery shopping to buying a car. Around half of these payments are between two individuals/businesses that use two different banks. These transactions are recorded through an exchange settlement account, which is a bank account that each Australian bank holds with the RBA. Banks are required to have a positive balance on their exchange settlement account. By the close of business, all payments are recorded in the exchange settlement account but they do not receive their receipts (money that they are owed) until the next morning. If there are too many payments causing a bank to have a negative balance, then they can borrow the shortfall from the RBA at 0.25% above the cash rate. If a bank has deposited more money into an exchange settlement account, then they will receive interest at 0.25% below the cash rate. This allows the banks to borrow and lend to each other at around the targeted cash rate.

How often are Cash Rates Changed?

The Reserve Bank board meets on the first Tuesday of each month (except January) to discuss the economic climate and at the end, discuss any need to change the cash rate. A media statement is released discussing the reasons why the RBA has decided to change or maintain the cash rate. A minute of the meeting is released around 2 weeks after and provides a more detailed account of the meeting.

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