How the Reserve Bank of Australia Dealt with the 2008 Global Finance Crisis - Example

How the Reserve Bank of Australia Dealt with the 2008 Global Finance Crisis Introduction The 2008 financial crisis originated from the United States of America sub-prime loans that resulted in financial difficulties across the world (Kearns, 2009). Different countries across the world have employed different strategies to mitigate and respond to the challenges brought by these crises (Reserve Bank of Australia, 2009). There major concern is ensuring that financial system is stable through utilisation of numerous measures (Stevens, 2009). Thus, governments have unveiled stimulus packages and financial strategies to combat economic challenges witnessed (Brown & Davis). The origin of the crisis can be traced to late 2007 when the prices of houses started falling, thus, exposing some homeowners who were not credit worthy (D’Arcy & Ossolinski, 2009). Therefore, the aim of this paper is to discuss how the Reserve Bank of Australia dealt with the 2008 financial crisis. Monetary Policy When it comes to monetary policies, different central banks can utilise different strategies to deal with it, and at the end, the aim is to ensure that the financial system has enough liquidity (H., & Lindsay, 2009). After ensuring that there is ample liquidity, the Central Banks have to combat the economic downturn associated with the policies (Reserve Bank of Australia, 2009). This, they can achieve through teaming up with different stakeholders including the government. In ensuring that the global credit squeeze is eased, three distinct categories of measures can be used to address (Reserve Bank of Australia, 2009). One of the strategies is providing an extended opportunity for the banks to request for funds from the central bank (Stevens, 2009). In the case of Australia, the Reserve Bank of Australia decided to increase the Aggregate Exchange Settlement balance from $1 billion to $10 billion. Since many of leaders aimed at short term maturities, the following graph illustrates RBA term deposits: When an economy of a region enters what is called a ‘systemic liquidity stage’, the central bank of that region becomes what is called the ‘lender of last resort’, since other financial organisations are not able to lend to each other (Reserve Bank of Australia, 2009). Thus, the Reserve Bank of Australia played this role through being a willing lender compared to other financial institutions. In addition, central banks also ensure that the collateral requirements are eased (Reserve Bank of Australia, 2009). For example, the Reserve Bank of Australia updated their requirements and included ABCP, RMBS, ABCP, and USD-denominated RMBS. Through utilisation of these strategies, the banks had enough liquidity that enables them to survive during tough financial conditions (Stevens, 2009). The second strategy that central banks usually use to champion their financial policies may include making direct purchase or providing loans that supports certain markets (Stevens, 2009). In the case of Australia, the Australian Office of Financial Management was directed by the government to purchase mortgages that are securities backed: the government provided $8 billion for this purpose (Brown & Davis). Moreover, the Reserve Bank of Australia utilised $730 million to start the MBS market. The third measure that central banks utilise is guaranteeing stabilisation of markets through supporting banks to raise debts (D’Arcy & Ossolinski, 2009). An example is the bankruptcy of Lehman Brothers where looses were up to $700 million meaning that if other looses where experienced in other banks, the industry could greatly be affected (Reserve Bank of Australia, 2009). To mitigate against such crisis, the central bank of States of America provided deposit insurance ensuring that the public and other stakeholders have confidence with the bank (Stevens, 2009). In the case of Reserve Bank of Australia, the bank guarantees were raised to $1 million dollars with any other amount above this, a fee was usually charged (Kearns, 2009). Moreover, conditions and credit rating was utilised to raise debt cheaply (Reserve Bank of Australia, 2009). Support of Economic Growth Any financial crisis usually results in numerous challenges both to the consumers and to businesses (Kearns, 2009). Such crisis reduces the amount of credit that businesses and consumers can access and also may contribute to declines in house prices and also share indexes (Reserve Bank of Australia, 2009). This means that consummation and investment are directly reduce contributing towards net loss of wealth (Stevens, 2009). According to the graph below, the confidence of consumer and business drops when financial crisis occurs. Such economic factors usually make many central banks to cut their rates quickly (Kolb, 2010). For example, the Reserve Bank of Australia cut their overnight cash rate to an ‘emergency level’ that usually is 3%. Cutting of rates across major markets is an important component that is commonly utilised by central banks to ensure that the crisis is stabilised (Reserve Bank of Australia, 2009). Therefore, the interest rate decrease reduces the cost associated with borrowing, increases expenditure translating into rising of short-run equilibrium output (Reserve Bank of Australia, 2009). Moreover, this approach also increases discretionary income, which also increases spending (D’Arcy & Ossolinski, 2009). Thus, the approach utilised by the Reserve Bank of Australia ensured the downturn of the economy was controlled promptly (Brown & Davis). Financial Policy Fiscal policy is usually associated to Keynesian approach whereby the governments concerned shortens duration of recession and supports short-term demand (Stevens, 2009). This is based on the fact that government spending is usually autonomous meaning that increase in spending will play an important role in the economy because of the component known has multiplier effect translating in increase in planned aggregate expenditure (Kearns, 2009). In addition, this strategy ensures that the short-term output gaps are addressed since consumption by private sector decreases (Reserve Bank of Australia, 2009). The Reserve Bank of Australia introduced two stimulus packages to ensure that the financial crisis difficulties were managed (Kolb, 2010). The first stimulus package worth $10.4 billion was for Economic Security Strategy while the second stimulus plan, which was worth $42 billion was for “Nation Building and Jobs Plan”, which boosted the economy immensely. The Reserve Bank of Australia main aim of this discretionary policy was to ensure that short-term and long-term incentives were provided (Brown & Davis). These two stimulus plans prevented the economy from technical recession resulting in a minimal growth in the first quarter. Moreover, the unemployment rate stabilised over the next months proceeding the 2008 period (Reserve Bank of Australia, 2009). In addition, the stimulus plan that was provided resulted in demand for new houses, and hence the recession was partly addressed (Kearns, 2009). Nevertheless, the demand for the houses made them more expensive making the stimulus when it comes to mitigating the cost of houses uneconomic (Reserve Bank of Australia, 2009). In addition, the Australian stimulus fund was not focused since the aim of most stimulus plans was to provide tax relief in which the Australian stimulus plan did not address (Stevens, 2009). Hence, the Reserve Bank of Australia stimulus packages was not targeted effectively and thus failing to provide tax relief. Conclusion The 2008 financial crisis has played an important role in understanding how central banks operates, how other financial institutions operates, and how these institutions exposures other sectors into financial crisis if proper policies and plans are not formulated and implemented. Utilisation of monetary policies and the three categories of measures according to the discussion above have provided effective and also targeted support for the financial institution and systems. This means that utilisation of both the fiscal policies and monetary policies have ensured that economic downturn has been addressed. The fiscal policy in place has only assisted in short term demand through better strategies may be used to addressed shortcomings associated with such approaches. To ensure that recession and other financial system requirements are addressed, it is paramount to ensure that other sectors such as private sectors are assisted and allowed to play an important role in ensuring that efficiency within the financial system is championed. References Brown, C., & Davis, K. Australia’s Experience in the Global Financial Crisis. Available at http://kevindavis.com.au/secondpages/acadpubs/2009/Brown-Davis_GFC_Kolb_chapter_final2.pdf D’Arcy, P., & Ossolinski, C. (2009). Australian Capital Flows and the Financial Crisis. Available at http://www.rba.gov.au/publications/bulletin/2009/nov/1.html Kearns, J. (2009). The Australian Money Market in a Global Crisis. 14th Melbourne Money and Finance Conference ‘Financial Globalization: Implications for Australian Financial Institutions and Markets’, 1–2 June 2009. Available at http://www.rba.gov.au/publications/bulletin/2009/jun/pdf/bu-0609-2.pdf Kolb, R. (2010). Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future. New York: John Wiley & Sons MP, H. W., & Hon. Lindsay Tanner, M. (2009). Updated Economic and Fiscal Outlook. Australian Government. Canberra: Treasury Publications. Reserve Bank of Australia. (2009). A Collection of Graphs on the Australia Economy and Financial Markets. Reserve Bank of Australia. (2009). Statement of Monetary Policy. Sydney: Reserve Bank Publications. Stevens, G. (2009). Opening Statement to House of Representatives Standing Committee on Economics. Canberra, ACT. Read More