Evaluating the Decision of Reserve Bank of Australia - Essay Example

Capital The global economic development has slowed down in the recent months in Anxiety regarding the banking and fiscal problems in the Euro segment is increasing the pressure on the global economy. The recent data suggests that the economic activities have contracted in Europe. While the US economy is estimated to have a modest growth, in Asia the growth seems to be sluggish. However, China is showing signs of sustainable and steady economic growth at 7-8 percent (Reserve Bank of Australia, 2012a). So analyzing the global economic scenario, it can be said that the growth rate at the end of 2012 is expected to be around 3.5 percent, which might pick up to 4 percent at the beginning of 2013. The prices of the Australian goods exports have decreased since May, due to the decrease in the price of crude oil, iron ore, etc. The Australian dollar price has appreciated over three months, despite the deterioration in the global economy and fragile financial condition. This study aims at evaluating the decision of Reserve Bank of Australia (RBA) for not changing the cash rate until December. The implications of cash rate in the economy of Australia, its effect and the effect of probable changes in the cash rate are also important issues that would be discussed in the study. The motive is to forecast the decision of RBA regarding changing the cash rate. Like the central banks in the industrialized countries, the RBA also utilizes interest rate on short-term basis, as an operating instrument in order to implement monetary policy. Under the current policy, the RBA has set a monetary policy by allotting a level of target for cash rate. RBA has been quite successful in achieving the cash rate as per its target level. The payment system of an economy represents the system by which the different agents settle their transactions. In case of Australia the major participants that can be considered in the payment system are the households or the firms, which can also be called the non-bank mass of public, the RBA, private banks and the federal government. The non-bank public use transaction deposits and currency for making payments and eliminating their debts if any. The transaction deposits are the banks accounts that can be used by cheques or through the debit cards. Money or currency is a liability for the RBA. So it can be said that the transaction deposits are also a liability for the banking system. It can be also said that the medium of transaction by a household or firm would also depend on the relative cost. The banks transact with the firms or households either through currency or through the transaction accounts. In such cases complications arise when the banks had to enter into transaction with each other and also with the federal government. Since settlement of debt through physical means would be quite expensive, so this problem is solved through the usage of clearing system. The process of clearing the debts among the banks through the accounts that the banks have with RBA is known as exchange settlement (ES). Now we would understand the cash market and the channel of cash rate, only then we would be able to understand why the RBA did not change the cash rate. The operations and functions of the cash market need to be understood before understanding the present market scenario. The interbank or cash market is nothing but the market where the banks can borrow and also lend money for short period of time. One of the most significant functions that the cash market serves is that it provides a platform to the individual banks to trade their ES funds. The requirement of the RBA market is that, the ES accounts are available in credit and this would provide an opportunity for the cash market to provide means of redistributing the ES funds among the ES account holders. The banks which have a shortage of ES funds can borrow it from those banks which have ES funds above the required level (Reserve Bank of Australia, 2012a). The two major feature of the cash market that should be discussed are: 1. though redistribution of funds is allowed in cash market, but it cannot be considered as an extra source of fund in the banking system. 2. The value of the loans that the cash market makes in a single day is larger than the ES funds in the banking system for a single day. It has been recorded in a recent survey that the cash transaction or the interbank loan amount was about $3.5 billion, compared to $0.75 billion of ES funds in 2003. The cash rate is the monetary instrument of RBA, which is used in the cash market. The term cash rates means interest rates charged on the overnight money market in countries like Australia and New Zealand. RBA has also declared a target level based on its policy objectives and economic condition. The problem that remains in this case is to measure the deviations in the declared target level and the actual level of the cash rate and try to minimize them. RBA tries to do so by establishing the reserve facility around the declared cash rate and also through daily OMO with the account holders of ES funds (Reserve Bank of Australia, 2012b). There are several interlinked reasons due to which the RBA had not made any changes to the cash rate, which was 3.50 percent. According to the governor of RBA Glenn Stevens, the major reason behind such hold was the moderate growth that was seen in the Australian economy and also the cuts in the cash rate that were done previously. Due to this the monetary policy was found to be uncomplicated in 2011, and the labour market in the country also showed employment growth. The downsizing has been low due to such decision by RBA. The decision of RBA to hold the changes in cash rate was considered a sign of good assessment of present economic situation and economic projections. The economy of the country is on track and the inflation is under control. However a lot of risk factor still remains high. The trade terms have declined, but the positive thing is that the rate of exchange still remains high (Reserve Bank of Australia, 2012c, p. 1-2) The cash rate before the rate cut was 3.50 percent. The first rate cut of the year took place in May 2012, was from 3.75 percent to 3.50 percent. The rate cuts have given much relief to the home owners in Australia. The rate cut by 0.25 percent has reduced the Australian mortgage by $60 per month. The sluggish decisions related to rate cuts were due to several reasons. The global economic growth seen in the second half of 2011 was very slow and it continued in the first half of 2012 too. The economic growth would be slow but there are lesser chances of downturn. However in the Asian countries, the signs of improvement have been seen, especially China. Australias condition is far better than the European markets and even US. The financial markets have improved a lot and the capital markets are also supplying funds to the banks and financial corporations. In Australia the credit growth have remained modest. The housing prices have stabilized after the decline of 2011, but still the housing market remains passive. The exchange rates are high in spite of decline in trade. Due to the occurrence of these phenomenons, the cash rate was reduced to 25 basis points. The target is to achieve the set target level cash rate based on the economic scenario (News Limited, 2012). The first cash rate cut of 0.25 percent took place in the month of May, then again in June it was further deducted by 0.25 percent, which remained unchanged till September 2012 to 3.50 percent. However it can be forecasted if the rate of inflation of Australia remains at a level of 2.5 percent, there would be further room for rate cuts in future. It was also expected that the RBA have cut the rates in July, September and again in December until it is decreased to 2.75 percent by the end of this year. This theory has been stated by The Australian Bureau of Statistics. The board also predicted that the favourable inflation condition would also provide scopes for an easy monetary policy, but RBA might also opt to keep the rate cuts on hold for this year keeping in mind the sluggish improvements in the global economic environment. Cutting down the cash rates have been welcomed because it has reduced the pressure of the high Australian dollar, reducing commodity prices and reduction in the investment plans in mining. The reduction in the cash rate would also shield from the European debt crisis. So it can be said that holding the rate cuts was not a good idea. It can be concluded that a too much of something is not good. Thorough rate cuts would lead to negative situations and holding on high cash rate for a long time also creates pressure on the domestic market. So a mixed or hybrid of both ways should be followed and balance should be maintained (Schwarten, and Cadden, 2012). References News Limited, 2012. Reserve Bank of Australia Keeps Cash Rate on Hold. [Online] Available at: < http://www.news.com.au/realestate/buying/reserve-bank-of-australia-keeps-cash-rate-on-hold/story-fndban6l-1226444895910> [Accessed 25 October 2012]. Reserve Bank of Australia, 2012a. Minutes of the Monetary Policy Meeting of the Reserve Bank Board. [Online] Available at: < http://www.rba.gov.au/monetary-policy/rba-board-minutes/2012/02102012.html> [Accessed 25 October 2012]. Reserve Bank of Australia, 2012b. Media Release. [Online] Available at: < http://www.rba.gov.au/media-releases/2012/mr-12-25.html> [Accessed 25 October 2012]. Reserve Bank of Australia, 2012c. Overview. [Online] Available at: < http://www.rba.gov.au/publications/smp/2012/aug/pdf/overview.pdf> [Accessed 25 October 2012]. Schwarten, E., and Cadden, J., 2012. RBA Points to a Rate Cut Next Month. [Online] Available at: < http://www.perthnow.com.au/business/rba-ignores-pressure-to-cut-rates/story-e6frg2ru-1226317601824> [Accessed 25 October 2012]. Read More