Unconventional Monetary Policy Overview
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Questions and Answers

What is the effective lower bound on the RBA’s cash rate target?

  • 0.15 percent
  • 0.20 percent
  • 0.05 percent
  • 0.10 percent (correct)

    • Which of the following is NOT considered an unconventional monetary policy tool?

  • Asset purchases
  • Negative interest rates
  • Forward guidance
  • Increasing tax rates (correct)

    • What was the total size of the RBA balance sheet in March 2020?

  • $100 billion
  • $190 billion (correct)
  • $245 billion
  • $437 billion

    • What effect do negative interest rates have on stored money?

    <p>They impose a fee for storing money.</p> Signup and view all the answers

    What is a characteristic of balance sheet tools in unconventional monetary policy?

    <p>They include asset purchases and liquidity programs.</p> Signup and view all the answers

    Which country had the most negative interest rate at −0.75 percent?

    <p>Switzerland</p> Signup and view all the answers

    What change occurred in the ESA balances from March 2020 to August 2024?

    <p>Increased from $32 billion to $245 billion</p> Signup and view all the answers

    Which unconventional monetary policy tool is primarily used for communicating future monetary policy intentions?

    <p>Forward guidance</p> Signup and view all the answers

    What is the primary goal of asset purchases by central banks during Quantitative Easing?

    <p>To reduce interest rates on a wide range of assets</p> Signup and view all the answers

    Which of the following defines 'Forward Guidance' in the context of monetary policy?

    <p>Communicating future policy commitments based on date or conditions</p> Signup and view all the answers

    What is one method used by central banks for conducting asset purchase programs during Quantitative Easing?

    <p>Setting price targets and allowing market quantities to respond</p> Signup and view all the answers

    What effect do large asset purchases have on interest rates?

    <p>Decrease interest rates on risky assets</p> Signup and view all the answers

    What is a key determinant of the effectiveness of Forward Guidance?

    <p>The credibility of the central bank</p> Signup and view all the answers

    Which central bank is noted for having introduced the term 'Quantitative Easing'?

    <p>Bank of Japan</p> Signup and view all the answers

    What is NOT a potential outcome of asset purchases during Quantitative Easing?

    <p>Increasing interest rates on longer-term safe assets</p> Signup and view all the answers

    What is the function of setting quantity targets in asset purchase programs?

    <p>To allow market prices to respond to asset purchases</p> Signup and view all the answers

    What was the cash rate increased to in May 2022?

    <p>0.35%</p> Signup and view all the answers

    What major monetary policy tool was discontinued in November 2021?

    <p>Yield Curve Control</p> Signup and view all the answers

    When did the last loans from the Term Funding Facility mature?

    <p>June 2024</p> Signup and view all the answers

    What was a significant issue with the RBA's forward guidance?

    <p>Confusion in communicating forecasts</p> Signup and view all the answers

    Which economic model is now needed to analyze the interactions between inflation and economic activity?

    <p>Aggregate Demand – Aggregate Supply Model</p> Signup and view all the answers

    What was a major criticism of the RBA's recent forward guidance?

    <p>It did not foresee a near-term cut</p> Signup and view all the answers

    What are the goals of extended liquidity programs?

    <p>To support financial stability</p> Signup and view all the answers

    What type of unconventional monetary policy involves directly influencing interest rates?

    <p>Negative interest rates</p> Signup and view all the answers

    What was the target cash rate set by Australia during the response to the coronavirus crisis?

    <p>0.1 percent</p> Signup and view all the answers

    Which program was part of Australia's extended liquidity measures during the coronavirus crisis?

    <p>$200 billion Term Funding Facility</p> Signup and view all the answers

    What does Yield Curve Control aim to target?

    <p>The interest rate on 3-year government bonds</p> Signup and view all the answers

    What type of loans did the extended liquidity programs initially allow based on existing bank lending?

    <p>Three-year loans</p> Signup and view all the answers

    What is the nature of the guidance provided regarding the cash rate during the response to the coronavirus crisis?

    <p>Time dependent</p> Signup and view all the answers

    What does the separation between monetary and fiscal policy depend on?

    <p>Selling bonds to the central bank</p> Signup and view all the answers

    What financing method is typically used for government budget deficits?

    <p>Selling government bonds</p> Signup and view all the answers

    In the context of Australia's monetary policy response, what has been a significant characteristic of the cash rate?

    <p>It remained above the zero lower bound during the GFC.</p> Signup and view all the answers

    What does liquidity refer to in financial contexts?

    <p>How easily an asset can be converted to cash</p> Signup and view all the answers

    What is the primary goal of lender of last resort facilities in a financial crisis?

    <p>To assist financially distressed institutions that are fundamentally sound</p> Signup and view all the answers

    What occurs when a bank must sell assets in an illiquid market?

    <p>The bank must engage in fire sales</p> Signup and view all the answers

    How do extended liquidity programs differ from traditional lender of last resort facilities?

    <p>They accept a wider range of collateral, including lower-quality assets</p> Signup and view all the answers

    What does quantitative easing generally involve?

    <p>Purchasing assets in the market to increase money supply</p> Signup and view all the answers

    What characteristic of a market does the term 'thickness' refer to?

    <p>The liquidity of the market</p> Signup and view all the answers

    What could indicate that a bank is 'fundamentally sound' despite facing liquidity issues?

    <p>It has a stable cash flow and adequate capital reserves</p> Signup and view all the answers

    What financial event can render a bank insolvent during an illiquid market situation?

    <p>A fire sale of its assets due to lack of liquidity</p> Signup and view all the answers

    A liquid asset can be converted to cash without much price impact.

    <p>True</p> Signup and view all the answers

    Extended liquidity programs only accept high-quality collateral during financial crises.

    <p>False</p> Signup and view all the answers

    Market liquidity does not change with economic conditions.

    <p>False</p> Signup and view all the answers

    Fire sale prices occur when banks are forced to sell their assets in a thick market.

    <p>False</p> Signup and view all the answers

    Quantitative easing involves purchasing assets funded by increasing ESA balances.

    <p>True</p> Signup and view all the answers

    Most central banks do not have facilities to help institutions during periods of market illiquidity.

    <p>False</p> Signup and view all the answers

    The goal of lender of last resort facilities is to allow fundamentally unsound banks to continue operating.

    <p>False</p> Signup and view all the answers

    Thicker markets are characterized by a greater number of good substitutes and higher liquidity.

    <p>True</p> Signup and view all the answers

    The effective lower bound on the RBA’s cash rate target is 0.10 percent.

    <p>True</p> Signup and view all the answers

    Negative interest rates mean that individuals earn interest on stored money.

    <p>False</p> Signup and view all the answers

    Asset purchases are a tool used in unconventional monetary policy to increase the central bank's balance sheet.

    <p>True</p> Signup and view all the answers

    The RBA's total balance sheet size increased from $190 billion in March 2020 to $437 billion in August 2024.

    <p>True</p> Signup and view all the answers

    Forward guidance is primarily intended to highlight past decisions made by the central bank.

    <p>False</p> Signup and view all the answers

    Extended liquidity programs can be seen as a response to the global financial crisis.

    <p>True</p> Signup and view all the answers

    The most negative interest rate recorded during the global financial crisis was −0.50 percent in Denmark.

    <p>False</p> Signup and view all the answers

    Liquidity refers to how easily assets can be converted into cash without losing value.

    <p>True</p> Signup and view all the answers

    Quantitative easing primarily involves selling low-quality assets to increase demand for risky assets.

    <p>False</p> Signup and view all the answers

    Forward guidance can be time dependent or state dependent, often to help reduce uncertainty in future monetary policy.

    <p>True</p> Signup and view all the answers

    Setting quantity targets in asset purchase programs allows market prices to remain fixed.

    <p>False</p> Signup and view all the answers

    The use of term 'quantitative easing' can be traced back to the practices of the Bank of Canada in the early 2000s.

    <p>False</p> Signup and view all the answers

    The efficacy of forward guidance is unaffected by the credibility of the central bank.

    <p>False</p> Signup and view all the answers

    The primary goal of asset purchases during quantitative easing is to drive interest rates down across a broad range of assets.

    <p>True</p> Signup and view all the answers

    Quantitative easing exclusively involves the purchase of government bonds.

    <p>False</p> Signup and view all the answers

    The goal of forward guidance is to improve the effectiveness of current policy by decreasing uncertainty.

    <p>True</p> Signup and view all the answers

    Australia's monetary policy response to the global financial crisis primarily relied on unconventional monetary policy.

    <p>False</p> Signup and view all the answers

    The target cash rate set by Australia during the coronavirus crisis was 0.1 percent.

    <p>True</p> Signup and view all the answers

    Australia's cash rate approached zero during the global financial crisis.

    <p>False</p> Signup and view all the answers

    The Term Funding Facility (TFF) provided 3-year loans at an interest rate of 0.25 percent.

    <p>True</p> Signup and view all the answers

    Yield Curve Control involves targeting an interest rate of 0.1 percent on 3-year government bonds.

    <p>False</p> Signup and view all the answers

    Forward guidance indicated that the cash rate would likely remain unchanged until full employment was achieved.

    <p>True</p> Signup and view all the answers

    Monetary policy in Australia has traditionally been separated from fiscal policy by selling government bonds to the central bank.

    <p>False</p> Signup and view all the answers

    Extended liquidity programs can provide banks with one-to-one access if they issue new loans to small businesses.

    <p>False</p> Signup and view all the answers

    The cash rate increased from 0.1% to 0.35% in November 2023.

    <p>False</p> Signup and view all the answers

    Forward guidance from the RBA is generally considered effective and clear.

    <p>False</p> Signup and view all the answers

    The last loans from the Term Funding Facility are set to mature in June 2024.

    <p>True</p> Signup and view all the answers

    Asset purchases under Yield Curve Control were discontinued in November 2022.

    <p>False</p> Signup and view all the answers

    A new theoretical framework is needed to analyze the interactions between inflation and economic activity.

    <p>True</p> Signup and view all the answers

    Negative interest rates are one of the four kinds of unconventional monetary policy considered.

    <p>True</p> Signup and view all the answers

    RBA's cash rate was increased to 4.35% by the end of 2023.

    <p>True</p> Signup and view all the answers

    Extended liquidity programs were created primarily to allow for new loans indefinitely.

    <p>False</p> Signup and view all the answers

    What unconventional monetary policy tool involves central banks purchasing financial assets to inject money into the economy?

    <p>Quantitative easing.</p> Signup and view all the answers

    How does negative interest rate policy function as a form of unconventional monetary policy?

    <p>It charges banks for holding excess reserves, effectively acting as a tax on stored money.</p> Signup and view all the answers

    What was the significant change in the size of the RBA's balance sheet from March 2020 to August 2024?

    <p>It increased from $190 billion to $437 billion.</p> Signup and view all the answers

    In what way does forward guidance play a role in unconventional monetary policy?

    <p>It provides information about the future path of monetary policy to influence market expectations.</p> Signup and view all the answers

    What is a defining feature of extended liquidity programs compared to traditional lender of last resort facilities?

    <p>They provide liquidity in a wider range of circumstances and often involve a broader set of collateral.</p> Signup and view all the answers

    What impact do asset purchases generally have on interest rates during a quantitative easing program?

    <p>They typically lower interest rates by increasing demand for financial assets.</p> Signup and view all the answers

    What economic condition would prompt a central bank to consider implementing negative interest rates?

    <p>A prolonged period of very low inflation or deflation and near-zero interest rates.</p> Signup and view all the answers

    What do banks need to provide in exchange for liquidity during extended liquidity programs?

    <p>High-quality collateral.</p> Signup and view all the answers

    What does it mean when an asset is described as liquid?

    <p>A liquid asset can be easily converted to cash without significant price impact.</p> Signup and view all the answers

    How do extended liquidity programs support fundamentally sound banks during a financial crisis?

    <p>They provide funding by accepting lower-quality collateral, helping banks avoid insolvency during temporary market illiquidity.</p> Signup and view all the answers

    What is the primary purpose of lender of last resort facilities?

    <p>The primary purpose is to prevent the failure of fundamentally sound financial institutions during times of market distress.</p> Signup and view all the answers

    What are the potential consequences of a bank having to sell assets in an illiquid market?

    <p>The bank may incur significant losses from fire sale prices, potentially leading to insolvency.</p> Signup and view all the answers

    What is the difference between a thin market and a thick market?

    <p>A thick market has many good substitutes and higher liquidity, while a thin market lacks these characteristics and is more susceptible to price impacts.</p> Signup and view all the answers

    In the context of Quantitative Easing, what occurs when central banks purchase assets?

    <p>Purchases increase the money supply by crediting ESA balances, often referred to as 'printing money'.</p> Signup and view all the answers

    What criteria are generally used to assess whether a bank is 'fundamentally sound'?

    <p>Criteria include the bank's capital adequacy, asset quality, management quality, earnings, and liquidity position.</p> Signup and view all the answers

    How does economic condition impact market liquidity?

    <p>Market liquidity is variable and can change based on economic conditions, affecting how easily assets can be traded.</p> Signup and view all the answers

    Describe what is meant by 'Quantitative Easing' and its main purpose.

    <p>Quantitative Easing refers to the central bank's large-scale asset purchases to inject money into the economy, primarily aimed at lowering interest rates and increasing demand for assets.</p> Signup and view all the answers

    What are the two methods central banks can use to conduct asset purchase programs?

    <p>Central banks can set quantity targets, allowing market prices to respond, or set price targets, letting market quantities respond.</p> Signup and view all the answers

    Explain the concept of Forward Guidance in monetary policy.

    <p>Forward Guidance involves communicating monetary policy intentions to manage expectations, which can be time-dependent or state-dependent.</p> Signup and view all the answers

    What is the significance of the credibility of a central bank in the context of Forward Guidance?

    <p>The credibility of a central bank is crucial because it determines the effectiveness of Forward Guidance in shaping market expectations.</p> Signup and view all the answers

    What types of assets are typically purchased during asset purchase programs?

    <p>Central banks typically purchase high-quality assets like government bonds and may also acquire low-quality assets like risky mortgage-backed securities.</p> Signup and view all the answers

    What role do asset purchases play in influencing interest rates during economic downturns?

    <p>Asset purchases aim to increase asset demand, thus driving down interest rates on both risky and safe assets, which stimulates investment.</p> Signup and view all the answers

    How did the approach to monetary policy shift from traditional tools to unconventional methods like Quantitative Easing?

    <p>The shift occurred as central banks moved away from traditional tools like interest rate adjustments to unconventional methods like Quantitative Easing to combat severe economic crises.</p> Signup and view all the answers

    What is the historical origin of the term 'Quantitative Easing'?

    <p>The term 'Quantitative Easing' originated from the Bank of Japan's use of the policy in the late 1990s and early 2000s, particularly for larger quantity targets.</p> Signup and view all the answers

    What was the target cash rate set by Australia in response to the coronavirus crisis?

    <p>0.1 percent</p> Signup and view all the answers

    How does the Term Funding Facility (TFF) enhance access to liquidity for banks?

    <p>It offers 3-year loans at 0.25 percent, allowing additional access for new loans to businesses.</p> Signup and view all the answers

    What is the primary purpose of Yield Curve Control in Australia's monetary policy?

    <p>To target a specific interest rate on 3-year government bonds.</p> Signup and view all the answers

    Explain the significance of forward guidance in the context of the RBA's monetary policy.

    <p>It communicates the bank's intention to keep the cash rate unchanged until economic conditions improve.</p> Signup and view all the answers

    What distinguishes conventional monetary policy from unconventional monetary policy during the GFC in Australia?

    <p>Australia primarily relied on conventional monetary policy without resorting to unconventional measures.</p> Signup and view all the answers

    What role does the Reserve Bank of Australia (RBA) play in the interaction between fiscal and monetary policy?

    <p>The RBA coordinates with the Treasury to manage liquidity and government funding through bond sales.</p> Signup and view all the answers

    Describe one characteristic of the liquidity programs introduced during the coronavirus crisis.

    <p>They allowed banks to access large sums quickly through targeted funding programs.</p> Signup and view all the answers

    In what way did the RBA's approach to monetary policy during the coronavirus crisis deviate from its historical practices?

    <p>It adopted unconventional tools like extensive asset purchases and yield curve control.</p> Signup and view all the answers

    What were the key changes to the RBA’s cash rate from May 2022 to November 2023?

    <p>The cash rate increased from 0.1% to 4.35% with increases in 0.5% and 0.25% steps.</p> Signup and view all the answers

    What is the purpose of the Term Funding Facility, and when did it close to new loans?

    <p>The Term Funding Facility was designed to provide low-cost funding to support lending and closed to new loans in June 2021.</p> Signup and view all the answers

    What issue did the RBA face with its forward guidance, and what was introduced to improve it?

    <p>The RBA struggled to effectively communicate its forecasts versus state-dependent policy, leading to reforms that included more channels for communication.</p> Signup and view all the answers

    What was a major characteristic of the RBA's asset purchase program, Yield Curve Control?

    <p>Yield Curve Control aimed to maintain specific interest rates on government bonds but was discontinued in November 2021.</p> Signup and view all the answers

    How does the Aggregate Demand – Aggregate Supply Model differ from the Keynesian model?

    <p>The Aggregate Demand – Aggregate Supply Model incorporates monetary and fiscal policy and analyzes both short-term and long-term economic dynamics.</p> Signup and view all the answers

    What challenges does the RBA face in its forward guidance amid market expectations?

    <p>The RBA may face credibility issues if its forward guidance does not align with market expectations, such as pricing in rate cuts.</p> Signup and view all the answers

    What are the key goals of extended liquidity programs during financial crises?

    <p>The key goals are to stabilize the financial system, ensure banks have access to funding, and maintain credit flow to the economy.</p> Signup and view all the answers

    What do recent trends in the RBA’s balance sheet indicate about its monetary policy approach?

    <p>Recent trends suggest an aggressive stance in tightening monetary policy to control inflation and stabilize the economy.</p> Signup and view all the answers

    In liquidity contexts, a liquid asset can be bought or sold without much price ______.

    <p>impact</p> Signup and view all the answers

    Extended liquidity programs expand the range of ______ accepted as collateral.

    <p>collateral</p> Signup and view all the answers

    Market liquidity can change with ______ conditions.

    <p>economic</p> Signup and view all the answers

    The goal of lender of last resort facilities is to help prevent financial institutions from failing when they are 'fundamentally ______.'

    <p>sound</p> Signup and view all the answers

    A bank may have to sell assets at a big discount during a ______ sale.

    <p>fire</p> Signup and view all the answers

    Quantitative easing involves the outright purchase of assets in an open market ______.

    <p>operation</p> Signup and view all the answers

    Most central banks have a lender of last resort type facility to help financial institutions navigate times of temporary market ______.

    <p>illiquidity</p> Signup and view all the answers

    In an illiquid market, a bank may be rendered ______ if forced to sell assets at drastically reduced prices.

    <p>insolvent</p> Signup and view all the answers

    The central bank expands its balance sheet, creating new ______ and using that money to purchase assets.

    <p>money</p> Signup and view all the answers

    The term 'quantitative easing' originates from the Bank of Japan's use of such policies in the late ______ and early 2000s.

    <p>1990s</p> Signup and view all the answers

    Asset purchases aim to ______ demand for assets.

    <p>increase</p> Signup and view all the answers

    Forward guidance refers to the communication of ______ policy.

    <p>monetary</p> Signup and view all the answers

    There are two kinds of forward guidance: time dependent and ______ dependent.

    <p>state</p> Signup and view all the answers

    Large-scale asset purchase programs are referred to as ______ in monetary policy.

    <p>LSAPs</p> Signup and view all the answers

    The goal of reducing uncertainty about the stance of future policy is linked to the ______ of the central bank.

    <p>credibility</p> Signup and view all the answers

    The RBA's cash rate target has an effective lower bound of ______ percent.

    <p>0.10</p> Signup and view all the answers

    One method of conducting asset purchase programs is by setting ______ targets.

    <p>quantity</p> Signup and view all the answers

    One unconventional monetary policy tool involves ______ purchases, also known as quantitative easing.

    <p>asset</p> Signup and view all the answers

    Negative interest rates can act as an effective ______ on storing money.

    <p>tax</p> Signup and view all the answers

    Extended liquidity programs and asset purchases are considered ______ sheet tools.

    <p>balance</p> Signup and view all the answers

    During the pandemic, central banks had to implement ______ monetary policy in response to the economic challenges.

    <p>unconventional</p> Signup and view all the answers

    In 2020, the total size of the RBA balance sheet expanded from $190 billion to ______ billion by August 2024.

    <p>437</p> Signup and view all the answers

    The most negative interest rate recorded in Switzerland was ______ percent.

    <p>-0.75</p> Signup and view all the answers

    Forward guidance is used to communicate future monetary policy ______ to the public.

    <p>intentions</p> Signup and view all the answers

    The Australian cash rate target during the response to the coronavirus crisis was set at ______ percent.

    <p>0.1</p> Signup and view all the answers

    Australia utilized the ______ Funding Facility to provide extended liquidity during the COVID-19 crisis.

    <p>Term</p> Signup and view all the answers

    Yield Curve Control targets a ______ percent interest rate on 3-year government bonds.

    <p>0.25</p> Signup and view all the answers

    The Reserve Bank of Australia is tasked with increasing ______ accounts through asset purchases.

    <p>ESA</p> Signup and view all the answers

    Forward guidance indicated no increase in the cash rate until progress towards full ______ was achieved.

    <p>employment</p> Signup and view all the answers

    The separation between monetary and fiscal policy is maintained when the government does not sell bonds to the ______.

    <p>central bank</p> Signup and view all the answers

    The Australian monetary policy response included a cash rate that did not approach the ______ lower bound during the GFC.

    <p>zero</p> Signup and view all the answers

    Extended liquidity programs allowed additional access of ______:1 for new loans to small businesses.

    <p>5</p> Signup and view all the answers

    The cash rate increased from 0.1% to ______% in May 2022.

    <p>0.35</p> Signup and view all the answers

    The Term Funding Facility closed to new loans in ______ 2021.

    <p>June</p> Signup and view all the answers

    Yield Curve Control was discontinued in ______ 2021.

    <p>November</p> Signup and view all the answers

    Forward guidance has faced criticism for being generally considered a ______.

    <p>mess</p> Signup and view all the answers

    The last loans from the Term Funding Facility are set to mature in June ______.

    <p>2024</p> Signup and view all the answers

    The new theoretical framework needed is the Aggregate Demand – Aggregate ______ Model.

    <p>Supply</p> Signup and view all the answers

    The RBA's unconventional monetary policy includes negative interest rates, extended liquidity programs, asset purchases, and ______ guidance.

    <p>forward</p> Signup and view all the answers

    Australia's responses to the GFC and Covid utilized ______ monetary policy tools.

    <p>unconventional</p> Signup and view all the answers

    Study Notes

    Unconventional Monetary Policy

    • Central banks use unconventional monetary policy tools when interest rates approach the effective lower bound (e.g., 0.10 percent for the RBA).
    • These tools include:
      • Negative interest rates
      • Extended liquidity programs
      • Asset purchases (quantitative easing)
      • Forward guidance
    • Extended liquidity programs and asset purchases are balance sheet tools, affecting the RBA's balance sheet.

    RBA Balance Sheet

    • The RBA balance sheet has significantly changed since March 2020 due to unconventional policy implementation.
    • Total size increased from 190billionto190 billion to 190billionto437 billion.
    • ESA balances increased from 32billionto32 billion to 32billionto245 billion.
    • Australian investments increased from 89billionto89 billion to 89billionto331 billion.

    Negative Interest Rates

    • Negative interest rates involve charging interest for storing money, essentially taxing money storage.
    • Several countries implemented negative policy interest rates during the global financial crisis (e.g., Denmark, Sweden, Switzerland).
    • Negative policy rates were generally not passed on to consumers and firms by banks, and actual market interest rates remained positive.
    • The RBA did not utilize negative interest rates during the global financial crisis or the coronavirus crisis.

    Extended Liquidity Programs

    • Extended liquidity programs expand lender of last resort facilities to help financial institutions navigate temporary market illiquidity.
    • These programs aim to prevent fundamentally sound institutions from failing, especially those playing a systemic role.
    • Extended liquidity programs involve:
      • Expanding the range of accepted collateral, including lower-quality collateral
      • Expanding the set of eligible counterparties
    • They make funding available at lower than usual costs.

    Asset Purchases (Quantitative Easing)

    • Asset purchases involve central banks buying assets in an open market operation.
    • This can be seen as a form of "printing money" as the central bank expands its balance sheet, creating new money to purchase assets.
    • This process was traditionally used to set policy interest rates before the shift to repurchase agreements (repos).
    • The US Federal Reserve and other central banks, but not the RBA, significantly increased asset purchase programs during the global financial crisis.
    • These programs aimed to increase demand and decrease interest rates on a broad range of assets, including risky and longer-term safe assets.
    • Asset purchase programs can be conducted by setting either quantity targets or price targets.

    Forward Guidance

    • Forward guidance refers to communication of monetary policy, aiming to reduce uncertainty and make current policy more effective.
    • There are two types:
      • Time dependent: commitments not to change policy until a certain date
      • State dependent: commitments not to change policy until certain conditions are met
    • The effectiveness of forward guidance depends heavily on the central bank's credibility.

    Unconventional Monetary Policy in Australia

    • Australia did not use unconventional monetary policy during the global financial crisis, relying primarily on conventional monetary and fiscal policy.
    • The RBA's cash rate did not approach the zero lower bound during this period.
    • However, unconventional monetary policy was utilized in response to the COVID-19 pandemic.

    Australian Monetary Response to Covid

    • The RBA implemented several unconventional policies during the COVID-19 pandemic:
      • Cash rate target set at 0.1 percent, with a corridor floor at 0.10 percent.
      • Extended liquidity programs, including the $200 billion Term Funding Facility (TFF) offering 3-year loans at 0.25 percent.
      • Asset purchases through Yield Curve Control, targeting a 0.25 percent interest rate on 3-year government bonds.
      • Forward guidance communicated through public statements about the timing of interest rate increases.

    Ongoing Challenges for Monetary Policy

    • Monetary policy faces ongoing challenges, including:
      • Unwinding unconventional measures:
        • Gradual increase in the cash rate from 0.1% to 4.35% in November 2023.
        • Closing of the Term Funding Facility and discontinuation of Yield Curve Control.
      • Forward guidance communication:
        • RBA struggled to communicate effectively between its forecasts and state-dependent policy, leading to criticism.
      • Monetary-fiscal interactions:
        • Large-scale balance sheet changes necessitate close coordination between Treasury and the Reserve Bank, blurring traditional distinctions.

    New Challenges for Monetary Policy

    • The evolution of the global economy poses new challenges for monetary policy, including:
      • The need for a broader theoretical framework that incorporates monetary and fiscal policy, inflation, and economic activity in both the short and long run.
      • Addressing the limitations of the Keynesian model, which focuses on short-run demand-side dynamics and lacks a place for monetary policy.
      • Analyzing the interactions between demand and supply shocks.
      • The development of the Aggregate Demand – Aggregate Supply Model to address these challenges.

    Unconventional Monetary Policy

    • Tools used to stimulate economic activity and lower interest rates when traditional monetary policy is insufficient.
    • Used because of the "zero lower bound" on interest rates.
    • Include negative interest rates, extended liquidity programs, asset purchases, and forward guidance.

    Negative Interest Rates

    • Banks are charged interest to store money, effectively a tax.
    • Implemented in some countries during the Global Financial Crisis, e.g., Denmark, Sweden, and Switzerland.
    • Not used by the RBA in response to the Global Financial Crisis or the COVID-19 pandemic.

    Extended Liquidity Programs

    • Designed to increase market liquidity by making funds available at lower than usual cost.
    • Include expanding the range of collateral accepted and the set of eligible counterparties.

    Asset Purchases (Quantitative Easing)

    • Involve the central bank purchasing assets in an open market operation, often financed by creating new money.
    • Used to increase demand for and drive down interest rates on a wide range of assets, including risky assets and longer-term safe assets.
    • Implemented through setting quantity targets or price targets.

    Forward Guidance

    • Refers to communicating the central bank's intentions regarding future monetary policy.
    • Includes time-dependent commitments (policy unchanged until a certain date) and state-dependent commitments (policy unchanged until certain conditions are met).
    • Goal is to reduce uncertainty about future policy and increase the effectiveness of current policy.

    Australian Monetary Response to the Global Financial Crisis (GFC)

    • Did not use unconventional monetary policy.
    • Relied on conventional monetary policy and fiscal policy.
    • Cash rate did not approach zero lower bound.

    Australian Monetary Response to COVID-19 Pandemic

    • Cash rate target set at 0.1 percent.
    • Extended liquidity programs: $200 billion Term Funding Facility (TFF) provided loans at 0.25 percent.
    • Asset purchases: Yield Curve Control program targeted a 0.25 percent interest rate on 3-year government bonds.
    • Forward guidance: Central bank communicated intention to keep interest rates low until inflation was sustainably within the 2-3 percent range and full employment was achieved.

    Unwinding Unconventional Measures

    • Cash rate increased from 0.1% to 4.35%.
    • Term Funding Facility closed to new applications in June 2021 and matured in June 2024.
    • Yield Curve Control discontinued in November 2021.
    • Forward guidance communication strategies continue to evolve.

    New Challenges for Monetary Policy

    • Inflation
    • The changing nature of work
    • The impact of climate change
    • The need to strengthen the financial system
    • The need to address inequality and social mobility
    • The need to manage the impacts of technological change

    Aggregate Demand – Aggregate Supply Model

    • A theoretical framework that incorporates monetary and fiscal policy, analyzes interactions between inflation and economic activity, and distinguishes between demand and supply shocks.
    • Replaces the Keynesian model, which has limitations in dealing with these issues.

    Unconventional Monetary Policy

    • Conventional monetary policy tools rely on RBA’s cash rate target, which has an effective lower bound of 0.10 percent
    • As the cash rate approached this lower bound, countries explored unconventional monetary policy tools
    • Negative interest rates: Instead of earning interest, depositors pay fees to store money effectively, acting as a “tax” on storing money
    • Extended liquidity programs: Expand the range of collateral accepted and eligible counterparties for lender-of-last-resort facilities, making funding available at lower than usual cost
    • Asset purchases: The outright purchase of assets in an open market operation, expands the central bank’s balance sheet, creating new money and using that money to purchase assets. Also known as quantitative easing
    • Forward guidance: Communication of monetary policy which can be time-dependent or state-dependent, aiming to reduce uncertainty about future policy and increase the effectiveness of current policy

    RBA Balance Sheet Changes

    • The RBA balance sheet has changed dramatically, reflecting the implementation of unconventional policy
    • Total size of the RBA's balance sheet tripled from 190billion(March2020)to190 billion (March 2020) to 190billion(March2020)to437 billion (August 2024)
    • ESA balances increased significantly, from 32billionto32 billion to 32billionto245 billion during the same period reflecting the shift from traditional to unconventional policy

    Australian Monetary Response to the Global Financial Crisis

    • Did not utilize unconventional monetary policy, mostly relying on conventional monetary policy and fiscal policy
    • The cash rate did not approach the zero lower bound during this period

    Australian Monetary Response to Covid

    • Cash rate: Target set at 0.1 percent with a corridor floor at 0.10 percent
    • Extended liquidity programs: $200 billion Term Funding Facility (TFF) provided 3-year loans at 0.25 percent with varying collateral requirements based on loan type and borrower size
    • Asset purchases: Yield Curve Control targeted a 0.25 percent interest rate on the 3-year government bond (AGS) through secondary market auctions, increasing ESA balances
    • Forward guidance: Assured continuation of low interest rates until “progress was made towards full employment and that we were confident that inflation will be sustainably within the 2-3 percent range”

    Challenges of Unwinding Unconventional Measures

    • Cash rate: Increased from 0.1% to 0.35% in May 2022, with subsequent rises to 4.35 percent in November 2023
    • Extended liquidity programs: Term Funding Facility closed to new loans in June 2021, and the last loans matured in June 2024
    • Asset purchases: Yield Curve Control discontinued in November 2021
    • Forward guidance: Criticized for difficulty in communicating the difference between forecasts and state-dependent policy

    New Challenges for Monetary Policy

    • Requires a new theoretical framework to analyze interactions between inflation and economic activity in both short and long run
    • The aggregate demand – aggregate supply model is needed to incorporate monetary and fiscal policy and differentiate the effects of demand and supply shocks

    Unconventional Monetary Policy

    • Due to the Reserve Bank of Australia's (RBA) corridor system, the effective lower bound for the cash rate target is 0.10%.
    • When the cash rate approached this lower bound, unconventional monetary policy tools were used, including:
      • Negative interest rates
      • Extended liquidity programs
      • Asset purchases (quantitative easing)
      • Forward guidance
    • Extended liquidity programs and asset purchases are considered balance sheet tools.

    RBA Balance Sheet

    • The RBA's balance sheet has significantly changed, reflecting the use of unconventional policies.
    • Total size increased from 190billioninMarch2020to190 billion in March 2020 to 190billioninMarch2020to437 billion in August 2024.
    • ESA balances grew from 32billionto32 billion to 32billionto245 billion, while gold and foreign exchange slightly increased from 100billionto100 billion to 100billionto103 billion.
    • Australian investments saw a dramatic increase from 89billionto89 billion to 89billionto331 billion.

    Negative Interest Rates

    • Instead of earning interest, money stored would be charged interest.
    • Effectively a tax on storing money.
    • Used in some countries like Denmark, Sweden, and Switzerland during the global financial crisis, with the most negative rate at -0.75% in Switzerland.
    • These negative rates were mostly not passed on to consumers and firms.
    • Not used by the RBA in response to the global financial crisis or the coronavirus crisis.

    Extended Liquidity Programs

    • Liquidity refers to how easily an asset can be converted to cash.
    • Liquid assets can be bought or sold with little to no price impact.
    • Central banks often have lender of last resort facilities to help financial institutions during times of temporary market illiquidity.
    • Extended liquidity programs help prevent financial institutions from failing during times of illiquidity.
    • These programs expand the range of collateral accepted and eligible counterparties, making funding available at a lower cost.

    Asset Purchases (Quantitative Easing)

    • Involves the outright purchase of assets in an open market operation.
    • Purchases are paid for by crediting ESA balances, increasing the amount of money in the system.
    • The central bank expands its balance sheet, creating new money to purchase assets.
    • Traditionally, this was used to set policy interest rates.
    • During the global financial crisis, central banks, like the US Federal Reserve, significantly increased asset purchases, buying high-quality assets like government bonds from traditional counterparties.
    • They also purchased low-quality assets, like risky mortgage-backed securities, from a broader range of institutions.
    • The goal is to increase demand and drive down interest rates across a range of assets.
    • There are two ways to conduct these programs: setting quantity targets or setting price targets.
    • The term "quantitative easing" originates from the Bank of Japan's use of these policies during the late 1990s.

    Forward Guidance

    • Refers to communication about monetary policy.
    • Can be time-dependent or state-dependent.
    • Reinforces the central bank's commitment to its unconventional policies, reducing uncertainty about future policy.
    • Its effectiveness depends on the central bank's credibility.

    Australian Monetary Response to the GFC

    • Unconventional monetary policy was not a dominant feature of Australia's response to the global financial crisis.
    • The RBA relied on conventional monetary policy and fiscal policy.
    • The cash rate did not approach the zero lower bound during this time.

    Australian Monetary Response to COVID-19

    • Cash rate targeted at 0.1%.
    • A $200 billion Term Funding Facility (TFF) was introduced with 3-year loans at 0.25%.
    • Yield Curve Control was implemented, targeting a 0.25% interest rate on 3-year government bonds.
    • Forward guidance emphasized a commitment to low interest rates for an extended period.

    Ongoing Challenges for Monetary Policy

    • The conceptual distinction between monetary and fiscal policy has become less clear with large-scale balance sheet changes.
    • Monetary and fiscal policy must be coordinated carefully.

    Unwinding Unconventional Measures

    • The cash rate was increased from 0.1% to 4.35% over time.
    • The Term Funding Facility was closed to new loans and matured in June 2024.
    • Yield Curve Control was discontinued in 2021.
    • Forward guidance has been subject to criticism for its communication effectiveness.

    New Challenges for Monetary Policy

    • The RBA's response to inflation is a significant challenge.
    • The need for a new theoretical framework to incorporate monetary and fiscal policy is emphasized.
    • The Aggregate Demand-Aggregate Supply model is proposed as an alternative framework.

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    Introductory Macroeconomics Lecture 10: Monetary Policy II PDF

    Description

    Explore the tools and implications of unconventional monetary policy used by central banks when interest rates hit the lower bound. This quiz covers the RBA's balance sheet changes, negative interest rates, and asset purchasing strategies. Test your understanding of how these policies affect the economy.

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