Will RBA Go For Unconventional Monetary Policy Amid Current Economic Scenario?

However, some market analysts believe that the Reserve Bank of Australia (RBA) might have to consider unconventional monetary policy, in case the conventional policy easing fails to stabilize the economy.

Let us first understand the difference between conventional and unconventional monetary policy:

Conventional and Unconventional Monetary Policy

The instruments available with the central bank of any country to expand or contract the money supply are categorized under conventional monetary policy instruments. This can be done through:

• Increasing or reducing interest rates
• Adjusting reserve requirements
• Altering marginal lending rates and the deposit rates

However, it is believed that the effectiveness of conventional monetary policy measures reduces in the periods of crisis. This is due to certain limitations on these measures, like the interest rates cannot fall below zero, and the reserve requirements cannot be reduced after a certain extent. In such cases, the central bank adopts unconventional monetary policy measures, that includes quantitative easing.

Under unconventional quantitative easing, the central bank purchases either government or other securities from the market (open market operations or OMO) to add liquidity to the market and spur economic growth.

Existing Scenario in the Australian Economy

The Australian economy is counted amongst the most resilient economies of the world due to its diversified, services-based economy with the ability to respond to global changes and strong regulatory institutions. Though Australia?s economy stands strong, the country has been facing subdued inflation and challenging labor market conditions for quite a long time now.

In order to establish balance in the economy, the RBA adopted conventional monetary policy tools this year by reducing the interest rates to a historic low level of 1 per cent. The bank made two consecutive rate cuts in June and July 2019, of 25 basis points each, to help inflation reach the target and support employment growth.

Consequently, as per latest ABS release, filled jobs in Australia grew by 0.5% (seasonally adjusted terms) in the June quarter 2019, as compared to a 0.2% rise in the previous quarter.?For the same quarter,?the annual?CPI inflation?surpassed the market expectations, increasing 1.6% against the expected 1.5 %.

However, as per ABS June quarter GDP results, the Australian economy grew 0.5% (seasonally-adjusted) and 1.4% through the year. Consequently, RBA has signaled for further easing of monetary policy if required to aid sustainable growth in the economy.

RBA?s View on Conventional Policy Easing

As per the RBA, the Board still has some scope for further easing in monetary policy at a cash rate of 1 %. The bank has, however, ruled out any chances of unconventional monetary policy considering the current scenario; however, it did not completely discard unconventional monetary policy options if circumstances were to warrant it.

In its June 2019 meeting, the bank examined the effects of low cash rates on household incomes. As per the RBA, assuming that interest rates would move in harmony with market pricing, the low interest rates will result in:

• Decline in interest payments and interest receipts of the household sector
• Reduction in net interest paid
• Increase in household disposable income

According to the RBA, the Australian households, in aggregate, benefit from the effect of lower interest rates. The bank mentioned that though the income of households with deposits is lower in case of low interest rates, the household sector broadly has about twice as much debt as deposits.

Effect of Interest Rate Changes

As per the RBA, the changes in interest rates influence employment, inflation and economic activity via various channels, including:

• Changing incentives for businesses and households to save instead of invest or consume.
• Changing the amount of interest businesses and households pay on debt, and the interest received.
• Altering the asset prices and exchange rate, possibly influencing household and business decisions.

The bank believes that the interest rate is one of the important determinants of investment, that is considered by the companies while making investment decisions. Usually, a reduction in interest rates leads to lending for some businesses/projects which otherwise would not have occurred at higher rates. Also, a lower interest rate drives housing demand, stimulating higher housing prices and greater household debt relative to income.

RBA?s View on Unconventional Monetary Policy

In its latest address to the House of Representative?s Standing Committee on Economics, the Australian central bank mentioned that there is no need to employ unconventional monetary measures at this point.

The bank stated some of the unconventional measures adopted by other countries across the world, which include:

The bank has drawn some key lessons from the experience of the other countries of the world that adopted unconventional measures to stimulate the economy, as mentioned below:

• The group of measures that support each other tended to be more successful than measures applied in isolation.
• The measures had been helpful in cases where there had been severe disturbances hindering the supply of credit.
• The effectiveness of unconventional measures depends upon the particular financial and economic conditions faced by each economy at the time and the structure of its financial system.
• The measures were found to be successful in reducing government bond yields, which in turn dropped the interest rates across the economy for private borrowers, since government bond yields are the risk-free rates supporting all these interest rates.
• It is essential for the central bank to communicate consistently and clearly about the unconventional measures when they are executed.

The central bank mentioned that most of the unconventional measures implemented by the other world countries are not new to Australia. As per the RBA, the bank had already adopted foreign exchange intervention and buying and selling of government securities as monetary policy measures in the past. Also, the bank has been involved in buying government securities for liquidity management purposes.

The RBA mentioned that, in case, the central bank had to apply the unconventional measures, the appropriateness would depend on the specific economic and financial market circumstances of the time. It can be inferred from the RBA?s perspective that there are more chances of conventional policy easing by the RBA in the future than the implementation of unconventional measures in Australia.

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