Unit 1
Unit 4
Policy Impact
Sustainable Economic Growth
The RBA charter states that monetary policy should be implemented with a view to improving the standard of living of all Australians. This implies that the RBA should seek to maximise the number of goods and services available in the Australian economy, and through that the citizens of Australia will be able to satisfy more of their needs and wants. As a result, we can say that monetary policy will have some impact on the ability of the Australian economy to achieve growth.
Interest rates represent an important demand factor affecting the achievement of growth in the Australian economy. In theory, when interest rates fall the discretionary income of participants in the economy will increase. As such, they will be able to increase their spending, and both the consumption and investment components of aggregate demand may increase. Lower interest rates can also lead to a depreciating Australian dollar. A lower value for the AUD may mean an increase in exports, and a decrease in imports. As such, the demand side impact of a lower target cash rate can be very significant. As such, it is very likely that the Australian economy will experience growth during times of falling interest rates. This can be seen on the following supply and demand graph:
It should be noted that the implementation of monetary policy has traditionally suffered from an 18 month impact lag. Although the cash rate can literally be changed overnight, it can take around 18 months for the impact of this change to be felt in the economy. As such, the RBA must plan 18 months in advance when making any policy decision.
During the last five years, this impact can be seen occurring in the Australian economy. There are several significant situations in which a change in the monetary policy stance has been instrumental in assisting the Australian economy to achieve the goal of sustainable economic growth.
For example, in September 2008, Lehman Brothers filed for bankruptcy in the USA. This set off a wave of economic worries around the world; confidence fell, and the ability of banks to secure credit fell. Many commentators began speaking about the economic climate as being similar to the great depression of the 1930s. The RBA acted to decrease the cash rate in October, and then again in November and December. In the December quarter of that year the Australian economy contracted by 0.5%. The technical definition of a recession states that it will be recorded when we see two consecutive quarters of negative economic growth, and so the figures for the March quarter were eagerly awaited.
As it turns out the Australian economy did not experience a technical recession. In fact, economic growth was positive for each of the four quarters in 2009, and by the end of that year the RBA was acting to increase the cash rate to minimise the possibility of future inflation. The actions of the Reserve Bank were very important in ensuring that Australian businesses had access to credit during this difficult period. Combined with the strong stimulus provided by the federal government, the RBA played a significant role in ensuring that Australia was one of the few economies to avoid recession during the financial crisis.
It should also be noted that on occasion an increase in the cash rate can also help us to achieve sustainable growth. This is because the word "sustainable" suggests that the growth which is being achieved is not resulting in any inflationary pressures in the economy. The strong recovery in the Australian economy in 2009 suggested that pressure on productive capacity was possible. The RBA acted to increase the cash rate, and by May 2010 it had reached 4.5% (after falling to 3% in 2009). These changes were made to decrease the chance of inflation increasing beyond the goal range, and therefore to ensure that economic growth was sustainable.
Current Page: Sustainable Economic Growth
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