Monetary Policy and the Reserve Bank of Australia
The Reserve Bank of Australia (RBA) was created by the Reserve Bank Act 1959 as “Australia’s central bank, which is responsible for managing the Commonwealth’s monetary policy, ensuring financial stability, and printing and distributing currency.” (Reserve Bank of Australia, 2011) This article in explaining the premise of the RBA and monetary policy will consider how monetary policy affects the overall economy. Placing under scrutiny, the immediate and long terms, monopoly held over market, fiat money purchasing power, asset price bubbles, tax inflation, political publicity pressure and inadequate economic knowledge. Acknowledging the power of monetary policy, seen to encourage economic growth and stability, lower unemployment, and predictable exchange rates with other countries.
The RBA uses two measures M1 and M2 to determine the money stock. Currency and demand deposits. “[Currency -] paper bills and coins in the hands of the public, [and demand deposits -] balances in bank accounts that depositors can access on demand” (Mankiw, 2015). Interestingly, the RBA concerns itself over the quantity leaving the quality of purchasing power to be under little concern. “[Placing] a much better idea of how many Federal Reserve notes are printed and circulating than the Treasury does of the weight and fineness of its gold assets.” (Paul, 2012) Here is a major concern that troubles the agenda and management of the RBA and its operations. “[You] can know too much you can know all of the facts of some economic problem oh yes you can put it this way that the aggregates…sums, averages which statistics offer you are no substitute for the detailed knowledge of every single price and their relations to each other which really guide economic activity that is a mistaken attempt to overcome our limited knowledge […]” (Hayek, 1985).
If the RBA has no direct control over rates, implementing monetary policy through domestic market operations is called upon. In explaining open-market operations, government bonds are basically an IOU (a debt contract outlining the borrower’s obligations to the bonds holder). Like all loans (except on non-repayment bonds) require the borrower to repay at a future date called the date of maturity. The holder in return establishes a rate of interest that the borrower will pay each period up until the maturity date. “Today there prevails a tendency to push the banks and the insurance companies more and more toward investment in government bonds.” (Mises, 2010) Raising the probability of credit risk, as more borrowers are accepted for bonds, more borrowers can default (fail to pay either interest or principle). The RBA is therefore, at risk of over supplying bonds to banks and insurance companies that cannot make repayments. “If there is any failure to carry 100 percent reserves or to make delivery when demanded, such persons or institutions would be subject to severe penalties.” (Paul, 2012) To counter this problem the RBA used the law to ensure banks and insurance companies have enough reserves now however, the RBA no longer uses reserve requirements and reserves can vary between different sized banks.
“Politicians, prevented from buying votes with their own money, have learned how to buy votes with the people’s money [and] promise to vote for all sorts of programs, if elected, and they expect to pay for those programs through deficits and through the creation of money out of thin air, not higher taxes.” (Paul, 2012) In considering fiscal policy relations to monetary policy it must be remarked of the implication that tax is similar to inflation. As interest is earned on bonds and income is taxed, under tax treatment bonds interest is also taxed. However, in conflict to liberty and protection/security placed on money, the RBA is endangering devaluing its own issued money, every tax coercively taking a percentage off each dollar. Since tax is considered and “[gold is money, it should be common sense that all] taxation of whatever sort be eliminated on all gold and silver coins and bullion.” (Paul, 2012) Even in insisting that tax be paid in the AUD encourages its monopoly over the market.
RBA has power over liberty, through the purchases and sales of government bonds in the nation’s bond markets to indirectly “change the money supply by a small or large amount on any day without major changes in laws or bank regulations.” (Mankiw, 2015) Monetary policy also conflicts with market forces and incentives as “[those] who invested […] funds in bonds issued by the government and its subdivisions [are] no longer subject to the inescapable laws of the market and to the sovereignty of the consumers.” (Mises, 2010) The RBA must try to achieve the equilibrium of money and take into account most notably not to cause asset price increases and bubbles. Where the quantity of money equals the quantity of money supplied is the equilibrium interest rate. When the quantity of money demanded balances quantity of money supplied it determines the value of money and price level. Though managed by individuals faced with special interests, of those who favour either increasing the money supply over those who favour reducing the money supply. Altering the supply of money can cause different affects. RBA purchases the publics bonds in the nation’s bond markets using created AUD, being then deposited in bank reserves adds more than $1 or held as currency adds exactly $1 to the money supply. (Mankiw, 2015) At one time the RBA expands the supply of money and another time it contracts the supply of money. RBA sells portfolio bonds in the nation’s bond markets where the public purchases using currency and withdrawn bank deposits, directly reducing the money supply in circulation and bank reserves/lending. (Mankiw, 2015)
“On the other hand, there are powerful objections to any plausible policy response that might be considered within the current policy framework, which largely assumes that markets handle the task of allocating financial assets better than central bankers or regulators can” (Carmichael and Esho in Bell, 2004). The market should not be regulated and be left to social cooperation without interference by any central bank. “[No] policy regime has yet succeeded in achieving monetary and financial stability in a liberalised system.” (Bell and Quiggin in Bell, 2004) Monetary equilibrium might be an ideal policy goal, but there exist knowledge and incentive problems that may make it an uncommon practice. “Part of the reason why financial and asset markets are subject to such mood swings is that the fundamental value of assets is very hard, if not impossible, to assess.” (Bell, 2004) Most of the boom and bust bubble in asset prices is caused by the central bank controlling the monetary policy (even still when it is not influenced by special interests). “Finally, there are laws on the books empowering the president [(and prime minister)] to compel delivery, that is, to confiscate privately owned gold bullion, gold coins, and gold certificates in time of war.” (Paul, 2012) Causing misalignment in the equilibrium of money.
“No rational economic activity can be conducted when the unit of account is undefined.” (Paul, 2012) The exchange rate set by the RBA through monetary policy determines and records the price of its currency against the price of all other currencies. “Since the AUD was floated in December 1983, it has moved in a wide range around an average of $A1.5 per USD.” (Reitz, Rülke, & Taylor, 2011) Making the conversion of the AUD to another currency easy in determining its current value, the determinants value of money rather than the value of goods. People don’t even see the gold value of money anymore, and store money in banks, and no more store gold with goldsmiths as people had generally done. Money acts as a “unit of account [is a measure] to post prices and record debts [is the most liquid asset as it can easily be transferred to the economy’s medium of exchange, but far from perfect as a] store of value […] to transfer purchasing power from the present to the future.” (Mankiw, 2015) Money is a result of social cooperation and trade to facilitate trade between parties, this is the reason it established itself as a unit of account. Money is liquid as it is easily accepted under government decree. Money is not a good place to store value as monetary policy continues to devalue it (to put this into perspective consider the RBA intervention on US dollar purchases in figure 1). “The fundamental value of the exchange rate can be described by the purchasing power parity (PPP) value […] as a measure of the equilibrium exchange rate.” (Vigfusson; Ahrens & Reitz; Manzan & Westerhoff in Maatoug, Fatnassi, & Omri, 2011) PPP, basically a theory of foreign exchange, relates the determination of prices and coexistence of different money.
Figure 1: Log US Dollar Spot Rate, PPP Fundamental and RBA Intervention
Source: (Reitz et al., 2011).
“While the Australian economy can be regarded as relatively small, the Australian dollar (AUD) is the sixth largest currency traded in the world market, and the AUD-USD exchange rate is the fourth heaviest traded currency pair (Bank for International Settlement in Reitz et al., 2011) Exchange rates explain the balance of trade between countries in that policy intrudes upon natural market forces encouraging at a certain time a country imports money and at another time exports money. RBA can favour a high or low exchange rate at any time, or be powerless when fixing the exchange rate giving quantity of money supplied independence from interest rate prices. A high AUD exchange rate makes foreign currencies more affordable in contrast, reducing the price of imports drives up demand for goods/services and increases asset prices, while decreasing expensive exports with a trade deficit, raising AUD purchasing power. Naturally the use of foreign currencies should lower the exchange rate. “If the monetary authority sells an overvalued currency, it reveals its commitment to a lower exchange rate.” (Reitz et al., 2011) A low AUD exchange rate makes foreign currencies more expensive in contrast, increasing the price of imports while increasing exports with a trade surplus, decreasing AUD purchasing power. Monetary policy is used to affect the exchange rate through three paths: income, prices and interest rates.
Income Australian incomes are determined by market incentives. Markets influenced by expansionary monetary policy supplying money and cheap credit make people aware of mal-investment and asset price inflation. To combat unemployment, businesses expand and people’s income and spending tends to rise along with imports. The sale of dollars for other currencies with more purchasing power increases along with new goods purchases and decreases the AUD exchange rate. Markets influenced by contractionary monetary policy tightening the money supply and cheap credit make people aware of declines in spending and asset prices. Raising the exchange rate lessens demand of foreign currency and imports as people’s incomes fall.
In 1993 the RBA adopted the inflation target. (Reitz et al., 2011) M2 is used to forecast inflation – inflation is the increase in the supply of money and its fall in purchasing power. Inflation is never actually reported, the RBA operates in the short-term money market with the power to set the cash rate. Measuring price increases on some consumer goods/services, through the percentage change in consumer price index (CPI) and the quantity theory of money, to explain the long-run determinants of the price level. “[The cash rate] centres around a relatively flexible inflation targeting approach whereby the cash rate [(an interest rate financial institutions earn on overnight bank reserves and currency)] is set in forward-looking attempts to keep underlying [CPI] inflation broadly within a target band of between 2 and 3 per cent [(just enough to prevent hyperinflation)] over the medium term.” (Bell, 2004) Purposefully increasing prices by 2 and 3 per cent per year excludes any price reduction occurred otherwise and does not measure asset prices (including share market) inflation. Prices unchanged may unknowingly have inflation that counter price decreases due to increased productivity draining purchasing power. RBA realises the trade-off between long-run inflation and short-run unemployment/production. The popularity of inflationary expansionary policy ignores productivity for full-employment. Policy decisions are important for the economy, though troublesome to control more accurately and less damaging than of the free market. Without a central bank for its collateral, banks issuing demand deposits without backed reserves (trading insolvent) are penalized and guided to only cause inflation temporarily, both guided by the bank run.
Prices “Steeply rising debt levels, ‘irrational exuberance’ in property and equity markets and soaring asset prices have been followed by inevitable corrections and crashes, often with severe effects on the wider economy.” (Bell, 2004) Here is the repeated ignorance of intervening in the market in that is recreated again and again by central banks all over the world, and in which the RBA should acknowledge this along with others and stop its operations and market control. Investors know that business cycle booms are great for manipulating, particularly the housing and higher education bubbles. Unsustainable in the long-run but profitable for the few in the short-run. Eventually generating recessionary busts amidst the devalued currency hurting saving and pensions. The ability to supply goods/services has not changed in response to policy, as is reliant on physical capital, human capital, natural resources, and technological knowledge, none which have been altered. Importing vital commodities (food and necessary resources) from country A to country B that are unable to be acquired by sufficient exports, makes the trade balance unfavourable. Exchange rates increase though unlike foreign exchange, commodity and services take longer to adjust prices to new money. Where commodity prices in country A during surplus production are lower by the amount of shipping cost, than during surplus consumption in country B.
Interest At worst, zero or negative rates arise as low rates and the recession quit producing intended aggregate demand rises. Money printing/making arise as zero rates quit producing intended inflation. Hyperinflation arise as money printing maxes out asset prices. Government debt defaults arise when money printing stops and bonds interest elevates. To prevent this worst case scenario, governors formulating monetary policy are given long terms in a bid to encourage independence from short-term political pressure. “Liberalisation and easy credit have been matched with a new competitive urgency amongst banks and an increasing array of lending institutions chasing market share with competitive rates, new financial products and often a relaxation of lending standards, aimed at enticing borrowers.” (Bell, 2004) Most directly benefit from low interest rates and can form powerful lobby groups, for instance mortgagees, politicians and voters, business borrowers, governments, share market investors, retailers all benefit from higher present consumption demand and home owners benefits from rising house prices. “Lower interest rates have made debt more affordable and encouraged higher borrowing.” (Bell, 2004) The lead borrower in favour is the government itself with all its market power, encourages the RBA to purchase government bonds, this incompetence creates budget deficits and allows itself to sell debt at low interest rates. Increased easy credit and money devalues the AUD and people try to rid money, as savers lose purchasing power and earn less interest in Australian banks and bonds. Exporters are at an advantage over importers.
In contrast, people who benefit from lower rates will lose when rates are increased. Savers earn more with high interest rates. Low interest rates slows inflation and doesn’t demine purchasing power or distort asset prices as much. Property bubbles are prevented with homes being purchased with saved cash and advances international investor asset interest return. High interest in place of low interest loans will increase repayment amounts and increase the number of defaults. Increased demand for AUD appreciates the currency value, easing inflationary pressure, strengthening the AUD against foreign currencies. Importers are at an advantage over exporters. Contractionary policy slowly increasing or even contracting the money supply, is in a biased weaker political position. “The result is, as John Maynard Keynes said many years ago, that not one man in a million understands who is to blame for inflation.” (Paul, 2012) The producer of inflation must be the creator of money and currency monopoly holder, the central bank. Why no other than the central bank currently has this right. “The counterfeiter is hunted down seriously and efficiently, and he is salted away for a very long time; for he is committing a crime that the government takes very seriously: he is interfering with the government’s revenue: specifically, the monopoly power to print money enjoyed by the Federal Reserve.” (Rothbard, 1994)
What RBA should do
“The Bank is clearly in a difficult position: it appears to want to slow credit growth and thereby cool the property sector, but is confronted by a hostile government keen not to upset the mortgage belt.” (Bell, 2004). What the RBA should do and what the RBA would do, need to be distinguished. Timing is crucial in any effective stabilisation policy, when new money enters the economy, it spreads unevenly and over time. “There is even the possibility that a policy response could make matters much worse if the impact of a lagged policy response coincided with a major asset bust.” (Bell, 2004) Benefits precede the costs when policy takes an expansionary turn, but the costs precede the benefits when policy turns contractionary. “The Bank has been careful not to describe conditions in the property sector as a bubble or a potential bubble […] a slow unwinding of prices in the property sector would not cause major problems […]” (Bell, 2004). Expansionary monetary policy favoured by government political pressure and inadequate economic knowledge, aim for short-run economic returns of low interest and exchange rates which cause unseen effects of mal-investment, restrictions on private/foreign currencies and lower purchasing power. “Also, the central bank may be unable to demonstrate convincingly, even ex post, that a policy tightening was necessary.” (Bell, 2004) The RBA shows no concern over this influence and continues to please investors at the sake of causing rapid asset price increases. “This intervention policy can be regarded as publicity disclosed in most cases because RBA interventions are generally conducted by entering the broker market directly and announcing the intervention publicly” (Edison in Reitz et al., 2011).
“One of my main difficulties is that nobody knows what the total quantity of money is money has so many different meanings.” (Hayek, 1985) “[Acceptance] of fiat money depends as much on expectations and social convention as on government decree.” (Mankiw, 2015) Fiat means in Latin “let it become”, “[…] governments would not effectively suppress at once any development in [the] direction [of competing currencies and] keen on preserving their monopoly […]”, therefore is controlled by bureaucrats, not politicians. (Hayek, 1985) “What economic calculation requires is a monetary system whose functioning is not sabotaged by government interference.” (Mises, 2010). “[Abolishing] the government monopoly of the issue of money would deprive governments of the possibility of pursuing monetary policy […]” (Hayek, 1985) “Such unrestricted freedom of choice would result in the most reliable currencies or coins winning public acceptance and displacing less reliable competitors [those] competing monies might be foreign currencies, private coins, government coins, private bank notes, and so on.” (Paul, 2012) Governments interfere when prosecuting counterfeiters, retaining monopoly of money or eliminating the gold standard, done for the sake of the preservation of its own solvency the RBA lets its gold reserve evaporate. “Monetary freedom ends where legal-tender laws begin.” (Paul, 2012)
Reference List (American Psychological Association)
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Maatoug, A. B., Fatnassi, I., & Omri, A. (2011). Sterilised interventions within a heterogeneous expectation exchange rate model: Evidence from the reserve bank of australia. Australian Economic Review, 44(3), 258-268. doi:10.1111/j.1467-8462.2011.00640.x
Mankiw, G. (2015). Principles of economics, 7th ed. United States: Cengage Learning.
Mises, M. 1949 (2010). Human Action, Scholar’s ed. United States: Yale University Press, Ludwig Von Mises Institute.
Paul, R. (2012). The Transition to Monetary Freedom. Retrieved [06/01/15] from <https://mises.org/library/transition-monetary-freedom>.
Reitz, S., Rülke, J. C., & Taylor, M. P. (2011). On the nonlinear influence of reserve bank of australia interventions on exchange rates. Economic Record, 87(278), 465-479. doi:10.1111/j.1475-4932.2011.00723.x
Reserve Bank of Australia. (2011). In Business: The ultimate resource. London, United Kingdom: A&C Black.
Rothbard, M. (1994). The Case Against the Fed, 1st ed. United States: Ludwig Von Mises Institute.
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