pretty much te opposite of the Fiscal Policy Strengths & Weaknessses
This is good for evaluating the " Effectiveness of monetary policy"
Strengths of Monetary Policy
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Flexibility
- The RBA meets every month as opposed to once a year, meaning it has a very low Decision Lag
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Neutral Political Stance, politics do not have an effect on it.
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More effective during periods of high aggregate demand & Inflation.
Weaknesses of Monetary Policy
- Less effective during a Downturn.
- You can use it to stop people from spending in a boom, however, in a downturn when people do not have much money, a lower interest rate won’t help as much.
This is largely a result of two of the transmission channels
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The Cost of Borrowing channel
- Businesses don’t necessarily react to lower C.o.B when Economic Confidence is low.
- Pertinant Example
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The Asset Prices channel
- Asset Prices are largely influenced by the expectation of future income that will come from an asset. Low Economic Confidence reduces this.
Companies aren’t prone to borrowing when Economic Confidence is low, decreases (Low Interest Rate), they don’t invest a large amount more.
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Broad (not targeted like like fiscal policy can)
This is largely due to two of the channels in the Transmission Mechanism, that being
Asset Prices are influenced by other factors as-well
- Asset prices are influecned by different factors, only partly the Interest Rate. for example, the expected future price of the asset.
Untargeted
Monetary Policy can not be applied to a single sector of the economy. It is a ”one size fit’s all policy”
- The RBA can not exclusively rise rates in a particular industry. e.g. car industry. A rise in the Interest Rate effects the economy as a whole.
- The RBA can not exclusively raise rates in WA, and keep them unchanged in the rest of the country if WA experience a downturn.
Extremey long effect lag (up to 18 monts)
This is because the Transmission Mechanism chain from the cash rate to changes in aggregate demand is indirect. as opposed to fiscal policy which is direct, imposing direct costs on the transactions themselves. reason for effect lag in Interest Rates
Recognition Lag
The Inherent Recognition Lag
Contemporary Limits of Effectiveness
Summary of RBA since 2016
There was a 3 year gap between RBA economic activity between 3rd of Augest 2016, and the 5th of June 2019, durign his period the InterestRate stayed constant at 0.25%.
Monetary Policy was in an expansioanry stance, since between 5th of June of 2019, and 4th of November 2020, the Cash Rate went from 0.25% all the way
Limiting Expansionary Monetary Policy
Current Levels of Inflation are due to Supply-side pressures.
Interest Rates can not really impact supply-side pressures, this is amplified by conflicting policy.
E.R Channel is not effective as seen by low exchange rates
Even though Australia has been raising the Interest Rate, economic confidence globally is low, and central banks in other countris, like the USA have increased their cash rate equivalent beyond the 4.1% of ours, reachign 5.5 per-cent, this means there is actually a negative Interest Rate differential between us and the US, simultaneously the US is also seen as a less risky target for investment in comparison to Australia. This has led to the current Ineffectiveness of the Exchange Rate Channel being less effective in influencing Aggregate Demand as our rising interest rates have not reduced International Competitiveness or imports as a result of a movement in the exchange rate.