1303AFE Lecture Notes - Lecture 9: Deflation, Monetary Policy, Potential Output
30 May 2018
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Week 9 Economics for decision making lecture notes
Monetary Policy
Objective
• Statement on the conduct of Monetary Policy
o The Reserve Bank and the Government agree on the goal of keeping
consumer price inflation between 2 and 3 per cent, on average, over the
business cycle
o Known as INLFATION TARGETING
Rationale for an Inflation- Control Target
• Two main benefits flow from adopting an inflation-control target
o The reserve ak’s poliy atios are ore learly uderstood y fiaial
market traders, so that savers and investors experience fewer surprises and
make fewer mistakes
o The target provides an anchor for expectations about future inflation
Controversy about the inflation- control targeting
• Critics argue that, by focusing on inflation, the Reserve Bank might raise the interest
rate, lower investment and exports and with a multiplier effect decrease aggregate
demand and push the economy into recession
• Supporters say that, by keeping inflation low and stable, monetary policy makes it
maximum possible contribution towards achieving full employment and sustained
economic growth
The conduct of Monetary Policy
• What is the Reserve Bak’s oetary poliy tools?
o Cash rate
• How does the Reserve Bank make its policy decision?
o By using the inflation target rule ( around 2-3% a year)
• How does the Reserve Bank implement its policy?
o When the Reserve Bank wants to slow inflation, it raises the cash rate
o When the inflation rate is below target and the Reserve Bank wants to avoid
recession, it lowers the cash rate
Monetary Policy in Action
• When the Reserve Bank implements monetary policy by changing the cash rate,
events ripple through the economy and lead to the ultimate policy goals
• Two types of Monetary Policy:
o EXPANSION Monetary policy
o CONTRACTION Monetary policy
Expansionary Monetary Policy
• The Reserve Bank Fights recession
o If inflation is below target and real GDP is below potential GDP, the Reserve
Bank takes actions that are designed to restore full employment
o Such action is referred to as Expansionary (Ease) Monetary Policy
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