Monetary Policy Stances §

Expansionary Monetary Stance §

• When there is upwards movement in the Cash Rate over a period of time.
  • Cash Rate is increasing.

Contractionary Monetary Stance §

• When there is a downwards movement in the Cash Rate over a period of time.
  • Cash Rate is going down.
• Effect of a Contractionary Stance;
  • Reduction in Overall Real GDP / Aggregate Expenditure
  • Reduction in overall price levels (Inflation)

Understanding the Neutral Monetary Policy Stance §

The Neutral policy stance is when we are at The Neutral Rate for the Cash Rate.

Real Policy Rate §

The Real Policy Rate refers to the Cash Rate adjusted for inflation. or;

The Neutral Rate §

The Neutral rate is a benchmark that helps us understand the monetary policy stance at any point in time.

• The Neutral rate is the Real Policy Rate that is Neither Expansionary, or Contractionary.
• The RBA reckons that gauging the Neutral Rate is challenging in practise since it cannot be directly observed.
  • • (from RBA. Meeting Minutes July 2022)
• The Neutral Rate must instead be inferred from Data. Rather than observation.
  • it is not possible calculate the rate itself or observe it.
  • Thus, Neutral Rate estimates must be treated with caution.
  • They are useful for assessing the Monetary Policy stance at any point though.

Neutral Rate Trends §

1990 - 2007 §

The RBA estimated a netural rate between 3 and 4 percent.

2008 - 2020 §

The RBA estimated a steady decline in the neutral, possibly being around 0.5 percent at the start of 2020 due to the long period of stagnant/slow growth after the GFC

2022 §

The book reckons the neutral rate would’ve risen somewhat because inflation is rising. (Contractionary Stance).

However,

• the Real Policy Rate would be negative
• This is because the Cash Rate is 2.85% and underlying inflation is around 5.5%
• / Cash Rate - Underlying Inflation Rate, comes out to;
• A negative Neutral Rate implies a Expansionary Stance, however simultaneously interest rates on housing loans rose from ~2.8% in April 2022 to 6.4% in November 2022

Impact of a Contractionary Stance §

100% In the models above we can see the impact of Contractionary Monetary Policy.

• AE. Model
  • A Higher Cash Rate reduces Aggregate Expenditure.
    • The Equilibrium level of income moves from to
• AD/AS Model
  • Assuming Economic Activity was beyond it’s potential, beyond the LRAS Curve, at , and price levels at
  • Contractionary Stance shifts AD curve to the left ( to )
    • This reduces both the rate of Growth, and the rate of increases in prices (Inflation)

Recent Trends in the Cash Rate (Monetary Policy) §

From this part of the book; Chapter 13 - Monetary Policy, page 4

Between 2015 and 2020;

• The RBA cut the cash rate several times reaching just 0.10%.
• It stood at 0.10% for a Year and a Half, this being the lowest Cash Rate in Australian History.
  • Around this period some countries even had a negative cash rate (japan)
• Rates rose rapidly after May 2022, in response to rising inflation.

Figure 13.4 - Cash Rate Targets 2015-2022 §

Weakness Indicated between 2015 and 2020

The Cash Rate Target fell between the years 2015 and 2020 from 2.25% to 0.1%, indicating weakness in the economy following the mining boom, and then the offset of the COVID Pandemic. In 2022 it rose to counter inflationary pressure.