ECON1102 Lecture Notes - Lecture 9: Monetary Policy, Core Inflation, Unemployment
9 – Central Banks and Monetary Policy
Central banks (CB)
• Make operational decisions about monetary policy
Often have a considerable degree of autonomy or independence in
implementing monetary policy
E.g. Fed (U.S.), ECB (Euro area), PBC (China)
Targets and instruments
• Monetary policy – decisions and actions taken by the central bank to influence short-
run macroeconomic outcomes
• Targets – final variables that CBs seek to influence
Inflation rate
Level of resource utilisation (i.e. output gap, cyclical unemployment rate)
CBs do not have direct control over ultimate targets
• Instrument – monetary policy instrument
Variable which the central bank can directly control
Eventually has a predictable effect on policy targets
Most CBs use a (very) short-term interest rate as their policy instrument
RBA – main functions:
• Stability and efficiency of financial markets
• Promoting efficiency of payments system
• Responsible for operation of monetary policy
Austalias oeta poli tagets
• Explicit inflation target (2-3% per annum)
• First formal Policy Statement was in 1996
Headline versus core inflation
• Headline = measured CPI (no adjustments)
• Core/ underlying inflation
Use some procedure to try & remove volatile, temporary fluctuations in inflation
Measure the longer-tem (underlying) trends in inflation rate
2 basic approaches:
(a) Remove historically volatile components of headline inflation
i. E.g. energy prices (Fed uses CPI less food and energy)
ii. Always removes the same items
(b) Eliminate a proportion of items with the highest and lowest rates of price
change
i. RBA uses trimmed mean inflation measure
Monetary policy framework
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2
• Stateets ‘BA idiate it has a fleile inflation target – takes output into
account in setting policy
‘BAs opeatig poedues
• Announces target value for the Cash rate → intervenes in Cash market to ensure:
Actual Cash rate = target Cash rate
Since 3 August 2016, Cash rate target has been 1.5%
Monetary policy decisions
• 11 monthly decisions on target Cash rate per year
Raise, lower or leave unchanged
Size of change is usually 25 basis points (100 bp = 1%)
• Increasing Cash rate = contractionary policy
• Decreasing Cash rate = expansionary policy
How does the RBA achieve its target for the cash rate?
• Cash – ollouial ae fo Ehage Settleet Fuds
• Exchange Settlement Funds – held in accounts by Australian banks at the RBA,
accounts called Exchange Settlement Accounts (ESAs)
Role of Exchange Settlement Accounts and Exchange Settlement Funds (Cash)
• Banks hold reserves at RBA in Exchange Settlement Accounts (ESAs)
Banks not allowed to overdraw their ESA
• Banks use ESAs to clear debts (or credits) with other banks
• If ANZ owes $20m to Westpac, funds simply transferred between their ESAs
• Inter-bank transfers will change the distribution of Cash, but will not affect the
overall level of Cash in the system
Overnight Cash market
• Suppose ANZ finds its level of Cash holdings at end of the day to be undesirably low
Overnight Cash market
(a) Specialised market where banks can trade Cash
(b) Borrowing and lending for periods up to 24 hours
(c) ANZ could borrow Cash from some other bank which might find itself with
more than it wants to hold
(d) Interest rate in inter-bank market = Cash rate
How does the RBA set its Cash rate target?
• Channel system
RBA provides banks with two automatic facilities for overnight lending and
borrowing – called standing facilities
Interest on Reserves (IOR) – RBA pays interest in funds held in ESAs at rate which
is .25% below its Cash rate target
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Central banks (cb: make operational decisions about monetary policy. Often have a considerable degree of autonomy or independence in implementing monetary policy. Targets and instruments: monetary policy decisions and actions taken by the central bank to influence short- run macroeconomic outcomes, targets final variables that cbs seek to influence. Level of resource utilisation (i. e. output gap, cyclical unemployment rate) Cbs do not have direct control over ultimate targets. Variable which the central bank can directly control. Eventually has a predictable effect on policy targets. Most cbs use a (very) short-term interest rate as their policy instrument. Rba main functions: stability and efficiency of financial markets, promoting efficiency of payments system, responsible for operation of monetary policy. Aust(cid:396)alia(cid:859)s (cid:373)o(cid:374)eta(cid:396)(cid:455) poli(cid:272)(cid:455) ta(cid:396)get(cid:894)s(cid:895: explicit inflation target (2-3% per annum, first formal policy statement was in 1996. Headline versus core inflation: headline = measured cpi (no adjustments, core/ underlying inflation. Use some procedure to try & remove volatile, temporary fluctuations in inflation.