Evaluate The Effectiveness of Australia's Monetary Policy in Addressing The Economic Issues Resulting From The Global Financial Crisis of 2008-2009

Evaluate the effectiveness of Australias monetary policy in addressing the economic
issues resulting from the global financial crisis of 2008-2009.

Monetary policy is a macroeconomic policy involving the administration of the cash
rate by the Reserve Bank of Australia, Australias central bank, which has a direct
affect on market interest rates. This affects the supply and cost of money in the
economy, which is done in order to maintain stability within the financial system. The
global financial crisis refers to the worldwide economic downturn as a result of the
collapse of the housing and banking market in the United States, which has resulted in
recession in many advanced economies including the United States of America, Great
Britain and Japan. In order to address the issues that arise due to the global financial
crisis, such as decreased economic growth, unemployment and inflation, Australia has
implemented monetary policy, which, in conjunction with fiscal policy and other
government measures, has effectively addressed these economic issues.
In order to maintain medium-term stability of the Australian economy, monetary
policy upholds three main objectives. These include maintenance of the stability of
the currency in order to retain stable purchasing power of the Australian dollar, which
is achieved through a 2-3 per cent consumer price inflation target. Monetary policy
also aims to maintain full employment by decreasing unemployment, and sustaining
the prosperity and welfare of the people of Australia, which is achieved through stable
economic growth.
To achieve these objectives, the Reserve Bank directly influences the money supply
within the Australian economy through determining the cash rate. Money supply
refers to the total amount of funds within the economy, defined as all currency and
bank deposits that can be used as a measure and store of value, a medium of
exchange, and a method of deferred payment. Monetary policy is achieved through
domestic market operations that occur through intervention in the short-term money
market. In the instance of increasing the money supply, the Reserve Bank loosens
monetary policy. This involves the Reserve Bank buying second-hand government
securities from commercial banks and large non-bank financial intermediaries that
hold exchange settlement accounts. These accounts are needed to settle transactions
with other banks and the Reserve Bank overnight, and work by a system of lending
1
and borrowing between banks. The cash rate is the interest rate paid on these loans. In
buying securities from banks, the Reserve Bank deposits funds in their exchange
settlement accounts. This increases the supply of settlement funds, placing downward
pressure on the cash rate. Banks can then decrease their market interest rates and still
maintain profit margins. By decreasing market interest rates, the money supply
increases.
In order to manage the effects of the global financial crisis, the Reserve Bank has
decreased the cash rate from 7.25% in September 2008, to a present rate of 3% as of
April 20091. This overall cut of 4.25%, or 425 basis points, has significantly increased
the money supply within Australian economy by affecting aggregate demand. As the
money supply increases, investment and consumer spending increases, affecting
aggregate demand and economic activity. This was designed to counteract the affects
of the global financial crisis, which includes decreased investment and spending,
decreased economic growth, increasing unemployment, and inflationary pressures.
Through interest rate cuts, monetary policy has affected economic growth. Lower
interest rates, particularly on housing loans, increase the disposable income held by
the consumer, which may heighten consumer confidence. This increases the supply of
money within the economy, which is more likely to be spent or invested, acting as an
injection to the economy. This has an overall affect of increasing aggregate demand
for goods and services within the economy, which is responded to by increased
production by firms, stimulating economic activity. This is evident through retail
sales, which amounted to $18 500 million in August 2008, prior to the global financial
crisis, which fell to $18 203 million in September 2008 due to the stock market crash,
and have increased to $19 531 million as of April 20092.
Also, a stable cash rate of 3% over a consecutive period of five months from April to
August 20093 may have further increased consumer confidence due to consumer
speculation that interest rates are unlikely to rise. As evident, consumer confidence
was largely affected by the stock market crash of September 2008 beginning the
1
ABC 2009. Official Interest Rate 2007-2009 31st August

http://www.abc.net.au/news/events/financialcrisis/charts/interestrates2year.htm
2
ABC 2009. Retail Sales- Seasonally Adjusted 2007-Present 31st August
http://www.abc.net.au/news/events/financialcrisis/charts/retailsales.htm
3
ABC 2009. Official Interest Rate 2007-2009 31st August
http://www.abc.net.au/news/events/financialcrisis/charts/interestrates2year.htm
financial crisis, though loosening of monetary policy, in conjunction with direct fiscal
stimulus has effectively addressed decreased spending due to the global financial
crisis.
Decreased interest rates also directly influence the investment and spending of
businesses. Not only may they receive extra revenue from increased demand by
consumers, but lower interest rates directly result in an increase in funds available as
less is being paid on existing debts, also making borrowing of funds and investment
more likely. This may result in economic growth, as evident through national Gross
Domestic Product (GDP), at 0.4%4 in June 2008, prior to the global financial crisis. A
decrease to -0.5% in December 2008 can be directly attributed as an impact of the
crisis, with the cash rate at 4.25%. Monetary policy can be viewed as ineffective
within the September to December period, as the decrease in the cash rate by 3% did
not have an expansionary effect on GDP, which contracted by -0.6%. However, many
other factors contributed to this downfall, including global influences and negative
business and consumer speculation, as well as the existence of a time-lag between the
date of policy implementation and effect on the economy. The increase to 0.4% GDP
in March 2009, however, can be attributed to loose monetary policy increasing money
supply, as economic growth returned to pre-financial crisis levels, proving reasonable
effectiveness in addressing decreased economic growth.
A key issue resulting from the global financial crisis is increasing unemployment.
Through the expansionary effects of loose monetary policy, unemployment is directly
addressed. Through an increase in money supply, employers are encouraged to retain
labour in order to meet an increased aggregate demand. Since September 2008, there
has been a large increase in unemployment, from 4.3% in September, increasing
rapidly from 4.5% in December to 5.7% in March, and remaining relative throughout
March to July, at 5.8%.5 In December, unemployment was relatively low at 4.5%,
whereas GDP had sharply decreased to -0.5%. This suggests that the sharp increase in
unemployment in the months to come may have been influenced by employer
4
ABC 2009. GDP Growth- Seasonally Adjusted 1990- Present 31st August
http://www.abc.net.au/news/events/financialcrisis/charts/gdpgrowth.htm
5
ABC 2009. Unemployment Rate 1999-Present. 31st August
http://www.abc.net.au/news/events/financialcrisis/charts/unemployment.htm
speculation taking precaution for another quarter of negative growth, rather than the
condition of the economy as affected by the money supply. From May to August 2009
unemployment has stabilised, at 5.7% in May, and 5.8% throughout June to August.
This can be attributed as a flow-on effect of loose monetary policy, as of the
relationship between the 3% cash rate, stable money supply and consumer and
business spending, as evident through retail sales, which have remained relatively
stable, decreasing only -1.4% from May to June 2009.6
However, although unemployment has remained steady at 5.8% since June, an
increase in part-time work and decrease in full-time workers has been a strategy
undertaken by employers in order to maintain profit margins and increase labour
productivity within the firm to address the effects of the financial crisis. Although an
increased money supply exists, the most recent statistics in labour underutilisation
indicate that underemployed persons represent 7.7% of the workforce as of May7. The
0.4% increase in unemployment indicates decreasing production by firms, which may
show that underutilisation is remaining stable or subject to slight increase. This results
in lesser effective resource allocation within the economy, meaning that the aim of
stable economic growth and development over a medium term, as an objective of
monetary policy, is not fully achieved. In this, it is evident that monetary policy has
direct effects on money supply, as consumer confidence, aggregate demand and
production of firms contributes to the level of unemployment. Therefore, monetary
policy is reasonably effective in influencing unemployment, though has unpredictable
outcomes that are affected by a range of other factors.
Finally, the third aim of monetary policy is to maintain the stability of the currency,
through upholding a consumer price inflation target of 2-3%. In the event of the
global financial crisis, downward pressure has been placed on inflation due to
decreasing aggregate demand, rather than a tightened money supply, from 5%
consumer price inflation (CPI) pre-crisis in September 2008, to 1.5% in June 2009.
Rather, low inflation has been achieved while the money supply has increased, which
6
ABS 2009. June Key Figures 31st August

http://www.abs.gov.au/ausstats/[email protected]/mf/8501.0
7
ABS 2009. Labour Underutilisation 31st August
http://www.abs.gov.au/ausstats/[email protected]/Previousproducts/6202.0Main%20Features2May%202009?
opendocument&tabname=Summary&prodno=6202.0&issue=May%202009&num=&view=
is a beneficial situation to stimulate economic growth, as consumers have higher

purchasing power and increased disposable income, which may increase aggregate
demand. This is an indirect impact of monetary policy in this situation, though in
conjunction with increased money supply, consumer confidence and fiscal stimulus
may have direct and effective impacts on managing the global financial crisis.
In addressing issues resulting from the financial crisis, including decreased consumer
and investment spending and economic growth, increased unemployment and
decreasing consumer confidence, monetary policy has proved to be reasonably
effective. The Reserve Banks loosening of monetary policy may have direct impacts
in effectively influencing the money supply, monetary policy effectively managed the
global financial crisis of 2008-2009 by existing in line with a range of other
determining factors, including global influences, consumer confidence and fiscal
policy.

Evaluate The Effectiveness of Australia's Monetary Policy in Addressing The Economic Issues Resulting From The Global Financial Crisis of 2008-2009

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Evaluate The Effectiveness of Australia's Monetary Policy in Addressing The Economic Issues Resulting From The Global Financial Crisis of 2008-2009

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Evaluate the effectiveness of Australias monetary policy in addressing the economic

issues resulting from the global financial crisis of 2008-2009.

ABC 2009. Official Interest Rate 2007-2009 31st August

ABS 2009. June Key Figures 31st August

is a beneficial situation to stimulate economic growth, as consumers have higher

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