Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

The global economy is expanding at a moderate pace, with some further softening in conditions in China and east Asia of late, but stronger US growth. Key commodity prices are much lower than a year ago, in part reflecting increased supply, including from Australia. Australia's terms of trade are falling.

The Federal Reserve is expected to start increasing its policy rate over the period ahead, but some other major central banks are continuing to ease policy. Equity market volatility has continued, but the functioning of financial markets generally has not, to date, been impaired. Long-term borrowing rates for most sovereigns and creditworthy private borrowers remain remarkably low. Overall, global financial conditions remain very accommodative.

In Australia, the available information suggests that moderate expansion in the economy continues. While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained. Inflation is thus forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.

In such circumstances, monetary policy needs to be accommodative. Low interest rates are acting to support borrowing and spending. Credit is recording moderate growth overall, with growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney and Melbourne, though trends have been more varied in a number of other cities. Regulatory measures are helping to contain risks that may arise from the housing market. In other asset markets, prices for commercial property have been supported by lower long-term interest rates, while equity prices have moved lower and been more volatile recently, in parallel with developments in global markets. The Australian dollar is adjusting to the significant declines in key commodity prices.

The Board today judged that leaving the cash rate unchanged was appropriate at this meeting. Further information on economic and financial conditions to be received over the period ahead will inform the Board's ongoing assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.

QUESTIONS

1. Should the FR raise interest rates, the FR will sell bonds to the private sector at a lower price. True or False.

2. In the new equilibrium, it is the new money demand that creates the new money supply. True or False.

3. According to the media release by Glenn Stevens, the FR is expected to implement contractionary monetary policy by raising the cash rate. Contractionary monetary policy reduces aggregate income because it:

A. Decreases the exchange rate and hence decreases net exports

B. Decreases planned investment by firms

C. Decreases planned saving by households

D. Decreases interest rates and hence aggregate demand

4. According to the media release by Glenn Stevens, "While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year." Suppose that Australia has an adult population of 50 million and a participation rate of 60%. The ABS uses the rule that anyone doing 1 hour's paid work or more is counted as employed. On this basis, suppose that it finds Australia has 24 million employed people.

What is Australia's official unemployment rate?

5. Refer to Q4. Suppose that the ABS now changes the rule for being employed to 10 hours paid work or more, and finds that Australia now has 22.5 million employed people. What is the new official unemployment rate? Assume that the labour force participation rate and adult population is unchanged. Round your answer to a whole number.

6. Refer to Q5. The 10 hour rule gives a more accurate measure of the true unemployment rate. True or False.

7. According to the media release by Glenn Stevens, inflation is forecasted to remain consistent with its target over the next 1-2 years. Inflation arises when:

A. The expenditure plans of agents exceed the supply of output by firms

B. The earning plans of agents fall short of what they earn in the economy

C. The currency appreciates in the foreign exchange market

D. A and B

8. The Australian government is concerned about inter-generational equity problems. Key problems arise from a larger number of older retired people being supported by a smaller workforce of young people, and from ever increasing budget deficits to be paid for by younger people.

Encouraging older people to stay in the labour force rather than retire would help fix this problem. True or False.

9. According to the RBA website, the current inflation rate is 1.5%. The RBA normally aims for inflation to be between 2 and 3 per cent. Since inflation is below 2%, and in reference to the media release by Glenn Stevens, why didn't the RBA reduce the cash rate?

A. Reducing the cash rate will discourage spending as it will cause prices to rise

B. Reducing the cash rate will discourage spending, causing business profits to fall and an increase in unemployment

C. Reducing the cash rate would encourage more spending and less saving

D. Reducing the cash rate would reduce the cost of borrowing and cause further rises in house prices

10. Inflation targeting aimed at a low and stable inflation rate is desirable because it:

A. Reduces uncertainty and helps agents plan for the future

B. Results in stable interest rates

C. Makes Australian exports more competitive overseas

D. Helps reduce problems caused by an ageing population