Monetary Policy Will Influence The Australia Economy

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Introduction After the deepest recession in the world economy following the Global Financial Crisis, the whole economy operated under a loose monetary policy. The starter was the three-round quantitative easing announced by the US Federal Reserve, and then followed by the European Central Bank and the bank of England. Despite the QE, most central banks started reduction of interest rate. On Mar 3rd, the Reserve Bank of Australia announced a cut in the cash rate by 25 basis points to 1.75 per becoming the lowest cash rate in history. The purpose of this research essay is to analyze and discuss how such monetary policy will influence the Australia economy. The focus of my analysis will be divided into three areas, the impact on inflation…show more content…
Lower cash rate provides cheaper borrowing rates to households and firms. Cheaper loan encourages households to spend more on goods and services; this increase in demands drives the prices up. For firms, lower cash rate reduces their costs of borrowing; in turn firms have a better chance to acquire properties, expand or paying more wages. So households have even more to spend. Therefore, lower cash rate tends to increase the inflation and decrease the unemployment rate. On the contrary, continuously lowering cash rate, which is what has been done by RBA in the past five years can signal to the market that economy is not growing substantially. Firms expect a lower return on the investments, and hence tight up their capital to avoid going liquidity. This may result into lower wages, and job-cuts. So without confidence of the economy in the future, lower cash rate may result in lower inflation and higher unemployment rate. However, almost for all the economic models, there is one tacitly accepted assumption, that is, everyone and everything being rational. Life has proved that this is not true, or at least, not always true. A simple example is that people often choose their interested job rather than the job gives highest NPV. In such manner, I will introduce the model of irrational household behaviour3 developed by Bojan Krstić and Milos Krstić. The model explains that households maximize their utility based on both current situation and previous experiences
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