Monetary Policy defines the strategic principles adopted by the central bank to manage the liquidity across the nation. The key objective of Monetary Policy adopted by nationâs central bank is to keep a close eye on inflation, unemployment and cash position in the market and then carry out adjustments to ensure the economic growth of the country.
Australian Monetary Policy is formulated by apex bank that is Reserve Bank of Australia (RBA). It is a central bank of Australia that is responsible for setting the countryâs official interest rate, called cash rate.
While setting monetary policy, RBAâs decisions are driven by three major targets that include the stabilization of the Australian Dollar, the maintenance of full employment in Australia and the economic welfare of Aussies. Further, the Reserve Bank uses an inflation targeting framework to guide its monetary policy decision making.
A relationship between interest rate and inflation:
There is always an inverse relationship between the interest rate and inflation. If the countryâs economy gets hit by inflation thereby ruining the value of the currency, the central bank will introduce tight monetary policy by raising the interest rate. In Australia, the official interest rate is called the cash rate at which RBA lends overnight money to commercial banks.
The cash rate influences other interest rates in the economy like interest rates for business loans, housing loans and interest rates on savings accounts. Boosting the cash rate directly impacts the domestic money market as the money supply in the market will get hindered due to expensive loans. That means now if one wants to borrow money for scalability in business, to buy property, or for other purposes, they will have to pay an increased amount of interest. The reduced liquidity will slash down people purchasing power, resulting in the downward shift in demand which means softening of prices and inflation getting back on track!
On the other hand, when the bank decides to inject money in the market, it announces interest rate cuts to fuel up corporate operations targeted at the overall economic growth of the nation. However, saving money in the bank with lower interest is the less preferred option for people which eventually results into the inflow of money in the market. In this manner, monetary policy also provides a stable financial system at the time of disruptive events or the softening of the economy.
RBAâs policy objective involves maintaining average CPI within the range of 2 to 3 % in near term. Whereas, Australiaâs cash rate has been kept unchanged to 1.5% as at 4 February 2019.
Formulation of Monetary Policy:
The Reserve Bank is an autonomous body that takes decision independent of the government. It ensures the prevention of monetary policy manipulation for political purposes. Australiaâs Monetary Policy is formulated by the Board of Reserve Bank of Australia (RBA) which comprises of total nine members including Governor and Deputy Governor. The decision of monetary policy is formed by a majority vote in the meeting held on the first Tuesday of every month.
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