The Role Of Central Bank In Australia: Evaluating Monetary Policy And Economic Environment Essay.

Role of a central bank in Australia in implementing monetary policy and regulatory requirements imposed on the central bank in performing its responsibilities

Discuss about the Report for the Role of Central Bank in Australia.

The present report examines and analyses the role of central bank of Australia. In this context, it evaluates the role of  central bank in Australia in implementing monetary policy, current economic environment of Australia, examination of effectiveness of monetary policy of the country, impact of the global issues on monetary policy and budget repair and the role of Authorized Deposit Institutions (ADI’s) in dealing with credit and operational risk. At last, the report also provides some recommendations to the central bank of the country in improving the economic growth of Australia.

The Reserve Bank of Australia is the central bank of Australia that is responsible for developing monetary policy of the country. The monetary policy of the country takes major decisions involved in establishing interest rate in the financial markets. The board of Reserve bank of Australia determines the interest rates for meeting the objectives determined in the Reserve Bank Act 1959. The major objectives determined in the Reserve Bank Act 1959 are stabilizing the country’s currency, maintaining full employment and promoting economic prosperity and welfare of people in the country (Bishop, 2012).  Thus, taking decisions regarding the interest rate is the main responsibility of the central bank of Australia that it performs through maintaining a uniform monetary policy in the country. The monetary policy developed through central bank of the country aims to promote sustainable growth of the economy through controlling inflation rates. Thus, the Reserve Bank of Australia encourages the long-term growth of the country’s economy through stabilizing the interest rates through the help of monetary policy developed. The monetary policy developed by the Reserve Bank Board forms a base on which the structure of interest rates in the country is established (Mayes and Toporowski, 2007).

The Reserve Bank of Australia conducts its operations under the supervision of Council of Financial Regulators (CFR), Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC) and the Australian Treasury. The central bank of the country regulatory shares its views and opinions with all these regulatory bodies for maintain the efficiency and effectiveness of the country’s financial system. The Reserve Bank of Australia has also membership in Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) that regulates the reforms imposed by the central bank on the financial system of the country (International Monetary Fund, 2012). The FSB examines and evaluates the vulnerabilities impacting the financial system and suggest possible measures to be implemented by the central bank in addressing them. On the other hand, BCBS develops the international framework for prudence regulation of the country’s banks. The Reserve Bank of the country works in co-operation with CFR agencies in the condition on occurrence of any crisis thus maintaining the financial stability. The CFR agencies advise the central bank of Australia about resolving the distress in the financial markets in emergency conditions (International Monetary Fund, 2012).

Current economic environment of Australia

The economy of Australia is categorized presently as one of the largest mixed economy internationally with GDP of approximately $1.62 trillion. The current economic growth of the country is estimated to be about 3.3% with inflation rate of 1.3 per cent. The Reserve Bank of Australia has presently kept the interest rates very low at about 1.75 per cent. This is mainly done by the central bank of the country to maintain a continuous economic growth despite of the decline in business investment (Letts and Ong, 2016). The lower interest rates is maintained by the RBA for meeting the demands of the domestic sector and thus to reduce the inflation. The RBA has developed and implemented the monetary policy for managing the exchange and interest rates in order to achieve the domestic objectives. The monetary policy developed by the bank plays a major role in overcoming the situation of high inflation through adjusting the interest rates. The conditions of high inflation may negatively impact the economic growth of the country by disturbing the price equilibrium. Thus, the monetary policy of RBA is particularly aimed at achieving lower positive inflation rate for maintaining the flexibility in the price systems (Campbell, 2016).

In addition to this, the monetary policy of the country has also taken into account a short-run trade-off between inflation and employment. This is done mainly to achieve the determined target of inflation as set up by the RBA. The short-run trade-off policy aims at easing of monetary policy under the conditions of any emergency for stimulating the economic growth. As such, the monetary policy of the country plays a pivotal role in cash market by influencing the short-term interest rates for overnight borrowing (OECD, 2014).  The monetary policy of RBA HAS ALSO significant effect on the asset prices as stock returns is highly influenced by the increase or decrease in the cash rate. As per the Capital Asset Pricing Model (CAPM), the monetary policy has a direct impact on the prices of assets through influencing their expected future returns. The participants in the financial markets make changes in their portfolio as per the changes implemented by the RBA in the monetary policy. The changes in the interest rate determined in the monetary policy announced by RBA cause significant changes in the financial markets through influencing the asset prices and yields. The increase in interest rate can enhance the asset prices and yields significantly and vice-versa (OECD, 2014).

Analysis of Mr. Morrison’s comments that central bank effectiveness has been exhausted

Mr. Morrison in the article ‘The Australian Treasurer’ has argued that the effectiveness of monetary policy developed by the central bank has exhausted. Mr. Morrison has stated that ability of monetary policy developed by the RBA is diminishing with cash rate at a record of 1.5 per cent. Thus, as per Mr. Morrison the effectiveness of central bank rate cuts has diminished and thus has opposed the further cuts in interest rates by RBA (Ryan, 2016). The comment made by Mr. Morrison can be said to be reasonable as the RBA should consider more opportunities for maintaining economic growth rather than reducing the interest rates more. The banking sector is largely negatively impacted by the negative interest rate policy through reduction in deposit rates. Also, the negatives rates on deposits can cause households and business to withdraw their cash from the bank thus causing instability in the financial market. Mr. Morrison in the article has suggested the use of alternative measures such as increasing the income of people and uplifting their living standards. The banking sector of the country is also emphasizing on the importance of fiscal policy for creating economic expansion (Caution over rate cuts 'reasonable': RBA, 2016).

Fiscal policy would help the government of the country to control the expenditure and tax rates and thus regulating the money supply. Thus, the establishing the fiscal policy would help the government of the country to use its revenue and expenditure sources for monetary stimulus in the country rather than cutting the interest rates. The current monetary policy developed by the Reserve Bank of Australia is losing its effectiveness as low interest rates are creating a pressure on the prices lading to accumulation of debts (Kehoe, 2016). The low interest rates maintained by the RBA would only lead to a short-term increase in the economic activity and can cause disrupt in the financial stability in the long-run. Thus, it can be said that the Mr. Morrison statement regarding the monetary policy ineffectiveness is reasonable as low interest rates maintained by RBA is posing several challenges to the stability of the financial system (Ryan, 2016).

The global financial crisis had a huge impact on making the monetary policy and budget repair difficult in Australia. The global issues that occurred after the occurrence of financial crisis such as collapse of large financial institutions negatively impacted the financial markets globally. The main reason behind the global financial crisis was collapse of US sub-prime mortgage market and busting of housing boom that results in disruption of global financial system. In addition to this, the withdrawal of the UK from European Union known as Brexit is further resulting in global financial stability. The weakening of the global financial systems resulted in posing several challenges before the monetary policy of Australia and making budget repair difficult. Brexit is also likely to have a wide impact on the US presidential election and the political system of the country. This is due to the large impact of the Brexit on the global economy recession. The fallout of Brexit has resulted in slowing down of economic growth and causing volatility in the financial market. The central banks are proving to be largely ineffective in maintaining the stability of the global financial system. This is mainly due to weakening of the British Currency and the U.S. has to look for new partners from the European Union countries (How Brexit Will Change the World, 2016).

Thus, the instability in the global financial system is further posing challenges before the Australia’s monetary policy effectiveness. The negative interest rate is creating pressure on the RBA decisions for further policy action. This can cause upward pressure on the Australian dollar with monetary policy becoming largely ineffective for further cutting down the interest rates. The government of Australia has only a potential option of implementing a fiscal policy on creating a match between government expenditure and revenues thus strengthening the Australian dollar (Assessing the implications of negative interest rates, 2016). However, with the weakening of the global financial system the Australian government is facing the challenge of increasing the tax revenue due to global recession. This would further cause the budget repair rather difficult and thus can hamper the successful implementation of fiscal policy by the government. The increase in housing prices in Sydney is further disrupting the financial system with upward pressure on the Australian dollar. Thus, the global issues such as financial crisis and fallout of Brexit are making monetary policy and budget repair difficult in Australia (Heath, 2016).

Authorized Deposit Institutions (ADIs) includes banks and credit unions of Australia that have gain authority from Australian government under the Banking Act 1959 to take deposits from customers. The ADI’s are developed by the Australian Prudential Regulation Authority (APRA) for greater supply of funds that are gained directly from the capital markets. The rationale behind the concept of ADI’s in Australia is to manage properly the deposits of investors by protecting it from the operational and interest rate risk (Apra Insight, 2012). The credit, liquidity, operational and interest-rate risk is lower for ADI’s industry in Australia and thus is responsible for the large success of authorized deposit taking institutions in the country. The industry has remained profitable and well-capitalized and has not gained recession over the past 20 years in the Australia. The banking sector globally faces large risk on account of the bank restructuring as it is impacted directly with significant changes in the European Union rules and regulations. The ADI’S however faces lower risk as it is not directly exposed to the fund markets and have limited exposure to economies of the European Union. Thus, global volatility has lower impact on the ADI’s thus they effectively deal with credit, liquidity, operating and interest rate risk in Australia (Apra Insight, 2012).

In addition to this, Basel Accords that are mainly the regulations of the banking sector namely Basel I, II, III also largely helps in dealing with capital and market risk. The banking regulations are established by the Basel Committee on Bank Supervision for ensuring that financial institutions have sufficient supply of funds for meeting their obligations (Peterson Institute, 2008). The Basel I that is first Basel accord aims at reducing the capital risk that is managing credit and liquidity risk faced by the baking institutions. As per the Basel I, all the banks globally are required to have a risk weight of 8% or less. The second Basel accord, Basel II, specially aims at reducing the market risk by encouraging sound banking practices. At last, Basel Accord III directs banks to maintain a minimum liquidity and equity ratio for preventing the occurrence of any financial crisis (Onyiriuba, 2015).

Conclusion

Thus, it can be summarized from the overall discussion held in the report that Reserve Bank of Australia plays a central role in regulating the monetary conditions in the country. The RBA is responsible for developing and implementing monetary policy that regulates interest rates in the country.  However, RBA needs to adopt strong measures for enhancing the effectiveness of monetary m policy in order to stimulate the economic growth of the country that is slowing down due to global challenges. In addition to this, ADI’s and Basel accords in Australia plays a large role in dealing with credit, liquidity, operational and interest-rate risks.

Thus, it can be recommended to the Reserve Bank of Australia on the basis of the overall discussion that it needs to make its monetary policy more effective by strengthening the economic growth of the country. The government of Australia is recommended to implement a fiscal policy in addition to monetary policy for promoting the growth of the banking sector. The RBA should develop a proper regulatory framework for protecting the impact of global issues on the economic growth of the Australia (Blanchard and  Sheen, 2013). The fallout of Brexit is posing several challenges before the RBA and the Australian government to ensure the effectiveness of monetary policy and repairing the budget deficit. The low-interest rates is negatively impacting the business investment thus causing the decrease in tax revenue collected by the government. This is responsible for trade deficit in the country and thus the government of the country is recommended to adopt a strong fiscal policy for creating a match between tax revenue and expenditure (Canavan, 2016). Also, it should support the growth of ADI’s industry in order to mitigate the liquidity and interest-rate risks as they do not have a direct exposure to euro economies as compared to that of banking sector. The APRA should also properly implement the Basel Accords for adequately managing the operational and market risk.

References

Apra Insight. (2012). Retrieved on 2 December, 2016, from https://www.apra.gov.au/Insight/Documents/12-Insight-issue-2.pdf

Assessing the implications of negative interest rates. (2016). Retrieved on 2 December, 2016, from https://www.ecb.europa.eu/press/key/date/2016/html/sp160728.en.html

Bishop, T. (2012). Money, Banking and Monetary Policy. Lulu.com.

Blanchard, O. and  Sheen, J. (2013). Macroeconomics: Australasian Edition. Pearson Higher Education AU.

Campbell, F. (2016). The Implementation of Monetary Policy: Domestic Market Operations. Retrieved on 2 December, 2016, from https://www.rba.gov.au/mkt-operations/resources/implementation-mp.html 

Canavan, G. (2016). Why Fiscal Policy Is About to Make a Comeback. Retrieved on 2 December, 2016, from https://www.dailyreckoning.com.au/fiscal-policy-make-comeback/2016/10/10/

Caution over rate cuts 'reasonable': RBA. (2016). Retrieved on 2 December, 2016, from https://www.skynews.com.au/business/business/market/2016/10/18/caution-over-rate-cuts--reasonable---rba.html

Heath, M. (2016). Australia Rejoins Global Disinflation Fight With Record Low Rate. Retrieved on 2 December, 2016, from https://www.bloomberg.com/news/articles/2016-08-02/rba-cuts-rates-to-record-low-to-counter-low-inflation-weak-jobs

How Brexit Will Change the World. (2016). Retrieved on 2 December, 2016, from https://www.politico.com/magazine/story/2016/06/brexit-change-europe-britain-us-politics-213990

International Monetary Fund. (2012). Australia: Basel Core Principles for Effective Banking Supervision—Detailed Assessment of Observance. International Monetary Fund.

Kehoe, J. (2016). Scott Morrison: No more RBA interest rate cuts. Retrieved on 2 December, 2016, from https://reia.asn.au/wp-content/uploads/2016/10/10-Oct-Scott-Morrison-No-more-RBA-interest-rate-cuts.pdf

Letts, S. and Ong, T. (2016). Interest rates left on hold by Reserve Bank at 1.75 per cent. Retrieved on 2 December, 2016, from  https://www.abc.net.au/news/2016-06-07/reserve-bank-leaves-interest-rates-on-hold-at-june-meeting/7484882

Mayes, D. and Toporowski, J. (2007). Open Market Operations and Financial Markets. Routledge.

OECD. (2014). OECD Economic Surveys: Australia 2014. OECD Publishing.

Onyiriuba, L. (2015). Emerging Market Bank Lending and Credit Risk Control: Evolving Strategies to Mitigate Credit Risk, Optimize Lending Portfolios, and Check Delinquent Loans. Academic Press.

Peterson Institute.( 2008). Banking on Basel: The Future of International Financial Regulation.

Ryan, P. (2016). Reserve Bank's interest rate cutting capacity may be at an end: Treasurer Scott Morrison. Retrieved on 2 December, 2016, from https://www.abc.net.au/news/2016-10-10/scott-morrison-rba-capacity-to-cut-interest-rates-end/7918334