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Unconventional Monetary Policy in Australia

Posted: Monday, October 26th, 2020

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The Reserve Bank of Australia (RBA) joined other central banks in advanced economies in unconventional monetary policy measures. Since the pandemic hit the world, most central banks did much more than lowering the interest rate to zero or below.

Unconventional monetary policy became the norm in some advanced economies after the 2008-2009 Great Financial Crisis. It all started with the Fed in the United States and the quantitative easing program. Next, the Bank of Japan expanded the concept further. Soon, all major central banks extended their toolkit with such measures. In some cases, some banks came up with pretty innovative solutions.

Unconventional Monetary Policy

The Reserve Bank of Australia and Unconventional Monetary Policy Measures

The first thing that the Reserve Bank of Australia (RBA) did in response to the COVID-19 pandemic was to slash the cash rate to zero. It followed in the Fed’s footsteps and responded quickly to the economic shock. Now the target rate is at 0.25%, considered the lower boundary by the RBA.

Next, the RBA strengthened its forward guidance. The RBA has three goals in mind when setting the monetary policy. One is price stability. Another is full employment. The third, coming as a result of the first two, is the prosperity and welfare of the Australian people.

The RBA used forward guidance to pledge that the cash rate remains to current levels until there is significant progress on employment. In other words, by doing that, the RBA assures economic agents that easy conditions remain in place until inflation reaches 2%-3%, and the bank sees consistent improvements in employment levels.

On top of that, the RBA purchases Australian Government Securities or AGS. It aims at reaching a 0.25% yield for the 3y AGS, further easing the monetary conditions.

Moreover, the RBA allowed banks to borrow from the RBA and lend to businesses and households. The so-called term funding facility works in a similar way to the TLTROs set by the ECB in the Eurozone.

Finally, the RBA decided to increase the interest rate that banks receive on Exchange Settlement balances to 0.1%. For those not aware, the RBA operates a corridor around the cash rate. By lowering the rate to 0.25, banks would have received zero interest rate, but the new decision helps the liquidity at banks.

Other banks in the developed world took similar unconventional monetary policy decisions. The signal sent is clear – lower rates for longer and super-easy monetary conditions for the years ahead.

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