Monetary policy is a macroeconomic policy, which involves actions by the Reserve Bank of Australia (RBA) to influence the cost and availability of money and credit in the domestic economy. While being a government entity, the RBA is purely independent of government control. Hence the Reserve aims to achieve three main objectives of sustained level of economic activity, price stability (low inflation) and full unemployment. Although due it being difficult to achieve all three objective simultaneously, as evident through high levels of fluctuation of inflation during the 1980s , the RBA has shifted it’s focus primarily on maintain low inflation within a range of 2-3%, as highlighted in the statement on the Conduct of Monetary Policy (2010). The Reserve Bank does not regulate the general level of interest rates directly, instead it influences the cash rate in the short term money market through its domestic market operations. The RBA influences the cash rate by affecting the Exchange Settlement (ES) accounts that banks hold at the RBA. The RBA can exercise direct control over the supply of funds in ES accounts through DMO. As the RBA can buys and sells Commonweal th Government Securities (CGS) in the money market in order to influence the level of borrowable fund available in the short term money market. If the RBA wants to adapt an expansionary stance it will buy back CGS from banks. When the RBA buys securities from a bank, it adding funds to the bank’sES account, thus increasing the supply of borrowable funds, which inturn reduces the overnight cash rate. Similarly if the RBA wishes to adopt a contractionary stanc e it will sell CGS to the banks. When the RBA sells securities to a bank, it withdraws funds from the bank's ES account, thus decreasing the supply of borrowable funds, which inturn increases the overnight cash rate. As a result of changes in the cash rate, financial lending institutions make corresponding changes in their interest rates. As such monetary policy will achieve its objectives as following : The fluctuation of the cash rates hence interest rates will affect the cost of borrowing and so the RBA can achieve its objective of price stability through it’s direct control of the cash rate. Hence though downward pressures on interest rates, it can decrease interest rates therefore increase demand, which through the interactions of supply and demand will increase prices as well as an increase in supply. And similarly the increase in interest rates will decrease demand, hence decrease inflation. Thus through the control of the cash rate, the RBA will achieve its main objective of price stability which since early 2000s has been quite effectiveness as it has maintained its target band of 3-4%. After it has achieved its initial goal of price stability, the RBA will aim to achieve economic stability and full employment. The fluctuatio n of cost of borrowing, which affecting the level of consumer and business borrowing, which hence will influence the level of aggregate demand and supply. As the RBA can encourage or discourage borrowing by both business and consumers, allowing it to control the level of consumption and business investment will inturn will influences the level of economic activity thus allowing it to sustain its desire level of economic growth, which is around 3-4%. Further its effectiven ess can be seen through the GFC, as Australia to be the only developed economy to resist a recession. Furthermore an fluctuation in aggregate demand will lead to fluctuation in the supply of output; which if increased will requires employment; or decreased will lead to higher prices and wages creating unemployment. Thus through controlling the aggregate demand hence supply of goods and services. The RBA can influence transmission mechanisms to achieve the natural rate of unemploymen t although it recent years can be seen as ineffective as the current rate is 6%, the highest since the GFC. In achieving these its objectives there will also be conflicts as demonstrated thorough the short run Phillip s curve.
