Policy Approach

Recent Monetary Policy Approach

In the Statement on the Conduct of Monetary Policy for February 2005, the RBA suggested that an increase in the cash rate was inevitable in the near future. This prediction ultimately came to pass in the following month. The primary reason given for this increase was the capacity constraints being experienced in the Australian economy. In other words, aggregate demand was increasing at a rate faster than aggregate supply could accomodate. For example, the RBA noted that the Australian labour market was experiencing a skills shortage, which was creating the possibility of demand side pressures on those markets that rely on skilled workers (such as trades people). Similarly, supply side bottlenecks were causing problems in export markets. The cash rate was increased by 25 basis points to 5.5% to help reduce demand side pressures.

The Cash Rate

In 2006 and 2007, the RBA became far more assertive about the need for a contractionary monetary policy stance in this country. Underlying structural problems in the economy (such as the skills shortage mentioned above, and also the drought, our dependence on imported petrol, and the ongoing possibility that wages will increase as a result of these factors) caused significant pressure on the rate of inflation during this period. After the election of the Rudd government in November 2007, the new Treasurer Mr Wayne Swann suggested that these pressures would result in a higher rate of inflation for all of 2008 and even 2009. As a result, it is perhaps not surprising that the RBA was even willing to act during the election campaign to increase the cash rate in November 2007. This is something which had never been seen before. More increases were seen in early 2008.

The actions of the RBA in the second half of 2008 were not predicted by any economic forecaster in the country. The credit crisis that had started in the USA began to push into the Australian economy, and it became apparent that low growth and unemployment were the problems that were most likely to be facing the Australian economy in 2009. To try and avoid this situation, the RBA adopted an extremely aggressive expansionary policy - the cash rate fell by 300 basis points in three months. This approach has not been seen since the recession of 1991, but at that time the cash rate was significantly higher, and therefore the RBA had more room to move. By the beginning of 2009 the cash rate had fallen to 4.25%, and it eventually fell to 3.0%.

However, as it became apparent that the Austalian economy was surprisingly resilient during the global financial crisis, the RBA began to move to remove the strong stimulus from the monetary policy stance. In each of the last three months of 2009 the cash rate was increased by twenty five basis points, and as a result the cash rate was 3.75% at the end of the year. This trend was continued in the early months of 2010; after a break in February, the RBA increased the cash rate in each of the next three months. As a result, by May 2010 the rate had increased to 4.5%.

(You should check the Reserve Bank's website regularly to keep up with changes to the cash rate during the year.)

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