Policy Approach

Strengths

The RBA has been extremely effective in achieving their goals in the last ten years. It follows, therefore, that there are certain strengths associated with the implementation of monetary policy.

On the end of year exam, there are two ways in which you could be asked to discuss the strengths and weaknesses of any particular economic policy. First, you could be asked to look at the policy overall. Secondly, you may be asked to assess the qualities of the policy in relation to one or more of the goals that you studied in Unit 3. For our purposes, we will examine the overall strengths and weaknesses, and then look at one way in which they can be applied to the individual goals.

Flexibility: The RBA is able to be very responsive to changes in the Australian economy. This is because the RBA board meets at the beginning of every month, and any change in the target cash rate can be implemented immediately (there is no implementation lag associated with monetary policy). As such, when Lehman Brothers collapsed in September 2008, the RBA was able to begin an aggressive series of cuts to the cash rate. In comparison, the budget (fiscal policy) is handed down only once each year.
Independence: The RBA and the government are separate entities. This is an intentional structure that was designed to ensure that decisions made by the RBA are made purely for economic reasons – never for political reasons. Once again, this is very different from what we can expect from the budget. For example, the RBA was willing to increase the cash rate during the 2007 election campaign, even though this was very damaging to the economic credentials of the Liberal Party. (Ultimately, the Liberal/National coalition went on to lose the election, and it does seem reasonable to assume that the actions of the RBA played a role in the change of government. However, it would certainly be unreasonable to assume that the RBA was politically motivated to make this change to the cash rate.)
Effectiveness: Due to the effectiveness with which monetary policy has been implemented in the last five years, consumers and businesses have become more aware of the process. As a direct result, the discussion of potential changes to the cash rate will often feature on the evening news reports and in newspapers. Increased awareness and increased information now mean that the Australian economy will respond effectively to the suggestion of changing interest rates, and as such the policy can be implemented even more effectively. For example, in early 2010 the RBA suggested several times that further interest rate rises were possible. The actual increases were not as strong as was first expected, as the economy responded effectively to the mere suggestion of a change.
Stability: Due to the manner in which monetary policy has been implemented during the last 10 years, the rate of interest payable on loans in Australia has been kept very stable. This has encouraged investment, and this in turn has helped to create growth.

You will now need to be able to relate these strengths to each of the goals that you have studied in the first half of the year. As full employment is a charter goal of monetary policy, we will use that as our example.

Throughout 2006 and 2007, the RBA was concerned about capacity constraints in the Australian economy. The cash rate was increased several times, ultimately peaking at 7.25% in March 2008. The increases that were seen at this time were administered over two and a half years, and each increase was only 25 basis points. This suggests the stability of the cash rate in Australia during this period.

In early September 2008 it was apparent that the global economy was entering a challenging phase, and so the cash rate was lowered by 0.25%. When Lehman Brothers collapses on September 15th, the RBA was aware that the global economic downturn was likely to be significant. Accordingly, the cash rate was cut by 100 basis points in October 2008, 75 basis points in November and a further 100 basis points in December. This demonstrates the flexibility of monetary policy at this time. It was also clear that the goal of the RBA during this period was to maintain employment; the IMF predicted that unemployment in Australia would reach 10%, and even the federal government suggested that a figure close to 8.5% was possible.

It is here that the effectiveness of monetary policy becomes clear. These cuts to the cash rate helped to ensure that the unemployment rate actually peaked at 5.8%, a figure well below the best estimates of many economists. The absence of political influence is also apparent here. The government at the time was selling the message that they were better economic managers than the opposition. The RBA was not concerned about which party was "better" at managing the economy; the cash rate was lowered to achieve an economic goal, rather than a political one.

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