Role of RBA in Australia

Government of a country intervenes in economic activities to ensure a stable economic performance. Fiscal and monetary policy are the two macroeconomic instrument for influencing aggregate demand and other economic variables. Monetary policy particularly aims to maintain a stability in the price level by influencing money supply and interest rate. Every economy tries to achieve a sustained economic growth along with a low inflation (Bernanke, Antonovics and Frank 2015). The Reserve Bank of Australia is the central bank of Australia. RBA conducts monetary policy operation with the objective of maintaining a strong financial system. The essay evaluates the article named “Is the deflation bugbear heading down under” drawing relevance to current economic stance of Australia.

RBA also has the responsibility to issue currency. The Reserve Bank being a policy determining authority provides some selected banking and other registry services the selected government agencies. It also provides assistance to some overseas central bank and other official institution. RBA also maintains the gold and foreign exchange reserve of Australia. The role and responsibilities of RBA is set by different legislation. RBA is a legislative authority which is established by Parliament’s act, the Reserve Bank Act 1959 (rba.gov.au 2018). The act provides specific obligation and specific power to RBA. Followed by the act, two boards of the central banks are: the Payment System Board and the Reserve Bank Board. It is the responsibility of Reserve Bank to ensure a stable banking and monetary policy directing it to the advantages of people in Australia. The primary roles of Reserve Bank Board are the following

1. Maintain stability in currency system of Australia
2. Guarantee full employment in Australia
3. Ensure economic prosperity and enhance wellbeing of people
4. Maintain stability in the price level

The role of Payment System Board is specified as

1. Control risk present in the financial system.
2. Promote efficiency in the financial in the payment system.
3. Promoting competition in payment service market which is consistent with general stability of financial system (rba.gov.au 2018).

Monetary policy indicates the actions of central banks to influence the financial and monetary policy condition. The broader objective is to achieve a low inflation along with a viable economic growth.  The Reserve Bank announces a desired state of monetary policy in terms of setting a targeted interest rate on overnight borrowed and lent money in the market. This overnight rate is known as cash rate. This is the interest rate that is directly affected by domestic market operation of Reserve Bank (Monadjemi and Lodewijks 2014). The targeted cash rate establishes operating objective for market activities of Bank. The main objective here is to maintain a balance between supply and demand in the cash market maintain parity with the desired cash rate.

Domestic market operation of RBA consists of two types of transaction in the market. The bank stands ready to buy the short term government securities with cash exchange. The government securities include Commonwealth Government Securities (CGS) that is Treasury notes or bond having a maturity period of less than one year. The Reserve Bank might enter in repurchase agreement. The bank acts with both State and Commonwealth government securities in the repo transaction (rba.gov.au 2018).

Monetary policy tools of RBA

The Reserve Bank of Australia has kept thee cash rate to a recorded low level at 1.5 percent in the September meeting. Interest rate decision of the central bank is consistent with the market expectation regarding central bank policy action with co-existence of low wage and low inflation. Worldwide, the inflation rate stays at a low level. In some economies however inflation has increase and is expected to increase further based on tight condition in the labor market. There is an ongoing uncertainty in the global market stemming from trade policy in United State. Central Bank forecast an average growth of Australia a little above 3 percent for the next two years. The economy in the first quarter of 2018 was estimated to grow above the trend growth rate (tradingeconomics.com 2018). There is favorable environment for business and investment in non-mining sector continues to increase. The economic growth also gains support from the investment in public infrastructure. The labor market outlook remains positive. The rate of unemployment has declined to 5.3 percent. The documented unemployment is the lowest in the past six years. The rate of inflation remains within the targeted inflation rate around 2 percent (rba.gov.au 2018). The Reserve Bank’s forecasted inflation rate is that the economy is currently experiencing. The low interest rate continue to support the economic growth. Reserve bank is expected to take further policy initiative to reduce unemployment rate and maintaining inflation within the target.

Measured inflation recorded in terms of a change in consumer price index hiked to 2.1 percent in the April quarter of 2018 compared to 1.9 percent inflation rate in last quarter. The expected inflation rate was 2.2 percent. The inflation increased mainly due to an increase in prices of electricity, tobacco and fuel. Cost of transportation raise by 5.2 percent compared to an increase by 2.9 percent in the previous quarter. Cost of transportation is mainly drive by the increase in fuel prices. Price increase significantly for tobacco, alcohol, culture, education, recreational, financial and insurance service. Price on the other hand has been eased for non-alcoholic beverages and food, housing mainly include electricity cost and health. Price has also been declined for clothing, footwear, communication, household equipment and service (tradingeconomics.com 2018). RBA reports that mean Consumer Price Index has increased by 1.9 percent matching expectation of the market. Based on Quarterly estimate the index increased by 0.5 percent which is unchanged from its trend from the past three month matching market estimate.

Current economic environment of Australia

In determining the monetary policy, the board members considers both domestic and global economic environment. Most advanced economies have accounted a growth rate that is beyond the trend growth rate. There is uncertainty regarding the US trade policy and its consequence on global market. There is evidence of a growing pressure on domestic economy following a slow growth in wages (Libich, Nguyen and Stehlík 2015). Condition in the global financial market has been found to be expansionary. Depending on present and future prospective economic condition, it was expected that Federal Reserve would increase the fund rate over 2018 and 2019. Present status of the Australian economy is consistent with the market expectation. Both unemployment and inflation remain within the targeted level. Housing price in Australia has declined Melbourne and Sydney. Considering the available condition, the board members of RBA decides to keep the monetary policy unchanged which would be consistent with targeted economic growth and inflation rate (thebalance.com 2018).

Financial state of the domestic economy has remained expansionary. Interest rate in the short term money market is higher than that in the three months ago. The Reserve Bank has kept the interest rate a 1.50 percent since the last two years Yields received from 10-year Government securities moved to a relatively lower level of 2.65 percent (rba.gov.au 2018). This has accounted a little change since the beginning of the year.

A decline in the neutral cash rate implies a risk free return. This leads to lower earning yield raising the ratio of price to earnings (morningstar.com.au 2017).  

Recession indicates an economic scenario where an economy records a considerable decline in the economic activities for a period more than six months. The decline in economic activity is normally traced by a decline in real gross domestic product, employment, real income, production in different industries and wholesale and retail trade (Goodwin et al. 2015). There are several factors that headed an economy towards recession. One such factor is inflation. Inflation represents a situation where average price level accounts a general rise for a period of time. Higher inflation means lower purchasing power of a certain sum of money. Under inflationary pressure people tend to reduce spending on leisure to lower overall spending. As a result of cut in spending, GDP starts to fall and unemployment as businesses lay off workers to lower their cost. All these mark a decline in economic activity leading to a recession.

Current monetary policy in Australia

At present, the economy of Australia is feared to experience a deflation very soon. This is because the current inflation rate is even lower than that targeted by the central bank. At present, price level has increased by only 1.9 percent as against the targeted inflation rate of 2 to 3 percent. There are several structural factors forcing the price level to a lower level. These include globalization, technological changes, labor market condition and changes in the inflation targeting policy different central banks. The increasing openness of former Soviet Union and China in combination with globalization enhance efficiency, provide source of a cheap labor force and open the domestic market to the competition with international market. In addition, reforms in labor market along with technological innovation induces a slow wage growth lowering bargaining power of workers (morningstar.com.au 2017). The global financial crisis dampened the inflation expectation dragging down further by weak demand, large output gap, high unemployment and dipping prices of a range of commodities.

Most countries currently experiencing deflation belong to the European region. Declining prices has become a trend in nations like Bulgaria, Croatia, Greece, Poland, Sweden and Spain. Germany, Thailand and Estonia though might not experience deflation on quarterly basis but there is possibility of deflation in the upcoming months (Libich, Nguyen and Stehlík 2015). In Italy and United State, the expected average decline in price is likely to be 0.5 percent. The increased competition and attention towards financial stability makes Australia and New Zealand more vulnerable to experience a likely deflation in coming months.

Leverage refers to the use of a tool or level in order to influence a larger gain relative to little effort. Leverage is generally used in debt in to raise profit. Leverage can increase reward from an investment at a faster pace. It is however also associated with high risk (Halling, Yu and Zechner 2016). Consequently, leverage is responsible for increasing volatility in the economic and financial market.

Debt is the lever in financial leverage. An investor can use money of other people that allows to access to a larger investment (Uribe and Schmitt-Grohe 2017). In Australian, the central bank has normalized the monetary policy by setting the interest rate to the level of 1.50 percent. Leverages accounts a significant proportion of return to shareholders during the phase of quantitative easing. The share of leverages was up to 50 percent. However, high level of debt worldwide has exhausted the return from leverages. This in turn has halted the growth in productivity.

Leverages affect various aspect of the economy. Future trading of commodities involve use of leverages (Aymanns and Farmer 2015). That is rather than borrowing at a rate of 50 percent, a consumer can borrow the same at a rate between 90 to 95 percent at a future contract. Leverage are also used in the Forex trading. This is because exchange rate accounts a very little change. The additional leverage is considered as safer than stocks (Ingves 2018). Consumer even prefers loans and credit. Consumer leverage explains the pattern of spending in an economy.

Conclusion

The Reserve Bank of Australia designs and executes Australia’s monetary policy. The primary objectives of RBA include issue of currency, maintenance of full employment, control the price level and finally maximizing the aggregate welfare. Additionally, RBA also controls money market transaction and aims to ensue financial stability. The main instrument used by RBA to influence economic activity is the overnight interest rate or cash rate. Currently inflation in Australia is below the targeted level. The monetary policy is normalized in terms of fixing the cash rate to a historically low level. The lower than expected inflation is now threating a deflationary situation with possibility of recession.

References list

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Reserve Bank of Australia., 2018. 3 July 2018 | Minutes of the Monetary Policy Meeting of the Board | RBA. [online] Available at: https://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/2018-07-03.html [Accessed 7 Sep. 2018].

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Reserve Bank of Australia., 2018. Statement on Monetary Policy – August 2018 | RBA. [online] Available at: https://www.rba.gov.au/publications/smp/2018/aug/ [Accessed 7 Sep. 2018].

Reserve Bank of Australia., 2018. The Implementation of Monetary Policy: Domestic Market Operations | RBA. [online] Available at: https://www.rba.gov.au/mkt-operations/resources/implementation-mp.html [Accessed 7 Sep. 2018].

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