Monetory Policies and Rba

Monetery policy is action taken by RBA to control inflation rates by using interest rate. RBA conduct monetary policies through open market operation (OMO). Open market operation can be defined as the buying/selling of financial instruments by RBA. The use of OMO by RBA cause the cash rate to change. Cash rate are interest rate on overnight loans between financial institutions including the RBA. The RBA uses the reserves Informational & Transfer system (RITS) to inform market about the changes in the interest rate. Financial institution has to be a member of this system to deal directly with the RBA. Most Australian financial Institution hold on ESA with the RBA. ESA, which is known as Exchange Settlement Account, enables real time gross settlement through the Reserve Bank.

There are 2 types of monetary policy, which is used, the expansionary & contractionary monetory policy. These 2 policies are normally used to fix the recessionary gap & inflationary gap when it gets too serious. A recessionary gap occurs when an economy is producing below full employment rate or when economy real GDP is below its potential GDP.

The solution to this problem is to use the expansionary monetary policy to increase the Aggregate Demand, to reduce the unemployment.

RBA used the OMO to buy back government bonds from financial institution. This would increase the reserve in the banks ESA accounts. This will then furthermore decrease the each rate, which will also decrease the interest rate. A decrease in interest rate will then cause investment to increase and interest sensitive consumption to increase. The fall of interest rate will then decrease the value of AUD causing AUS product to be on demand. This will then increase the AUS next export hence causing Aggregate Demand & GDP to increase.

The solution to this problem would be to use a contractionary monetary policy to reduce the Aggregate Demand to reduce price items. When RBA uses open market operation to sell government bond to see to the financial institution. When financial institution buy bonds from RBA, the reserve in the bank exchange settlement will decrease. A decrease in the ESA will cause the cash rate to increase.

An increase in cash rate will increase the interest rates. An increase in interest rate will cause consumer to reduce borrowing from bank and to put money in the bank as interest returns are high. This will cause Aggregate Demand to decrease. Furthermore, an increase in interest rate will increase the value of AUD hence causing net export decrease.