Unit 4 Economics AOS1 Monetary Policy 2020 Open Market Operations

Alright. Hello, hello everyone and welcome to our second video in our series for monetary policy. Today we're going to be looking at open market operations. Last time we just looked at what interest rates and monetary policy are. A little bit about the RBA's charter goals. If you're me, that was like three weeks ago. So the fact that I remember that is a little bit impressive. I hope you're doing well. We've only got this and two more videos for monetary policy and then a couple for aggregate supply and then we are completely done with unit four economics. So let's get started. So today we're going to be looking at the role of open market operations in altering the interest rate overall. What the RBA does in the short term money market, which you're going to learn about and how that alters the interest rates overall. It's going to have a little bit of going back into aggregate demand, aggregate supply side overall demand supply diagram stuff that you looked at in the past and that might give you a little bit of ptsd, but let's hope that it is all good. So there are specific instruments the RBA uses in terms of monetary policy. There are three things that they mainly do. They can alter the cash rate, which ultimately impacts interest rates. They can influence the exchange rate for the Australian dollar through what's called a dirty float or changes in interest rates, which also affects the value of the Australian dollar. A dirty float. We'll look at a little bit more later on. But it's basically when the RBA buys or sells a lot of currency to then affect the value of the Australian dollar. And there's also RBA persuasion which is about the desired direction of lending activities of the financial sector, which is basically in the rba. I always describe this as the rba essentially like being the annoying little sibling that's trying to bully their banks into doing certain things. Come on, come on. Lower your interest rates. Come on, do it, do it, do it, do it. Which has been happening a lot with the big banks recently trying to the RBA saying that lowering interest rates, the cash rate only works if the banks also pass on some or all of that cut. And the banks have been a little bit stingy with passing that on in recent times. So this next slide has a bunch of really, really important definitions about what we're going to look at. So the RBA using open market operations to influence interest rates. Firstly, we've got the official cash rate, which is the interest rate set by the RBA for the the short term money market and indicates its monetary policy stance. So it's basically the target of interest they want to achieve and hoping that by changing the overall amount of cash available in the short term money market will lead to the interest rate getting to that target. We've got the short term money market, which is a specialist financial institution where credit is borrowed and lent for short periods. So basically this is where the RBA and banks exchange money. So credit is given to the banks and lent and basically it's all lent at. And the amount of money that's available decides the overall cash rate, which is a little bit complicated, but we'll get into it a little bit later on. Then we've got open market operations which relate to the strategies of the RBA in the short term money market, involving the sale and repurchase of government securities or bonds with the aim of pushing up or lowering the cash rate. So basically, by selling or repurchasing government securities, the RBA affects the money available in the overall money supply. If there's less money available, it pushes up interest rates or pushes up the cash rate. And if there is more money available, it lowers the cash rate. Now we've got the monetary policy stance, which is whether the RBA wants to use interest rates to increase or decrease accurate demand so they can have an expansionary or a contractionary stance. In recent times it used to be said that Anything under either 3.5 or 4.5 is an expansionary stance, but we're not going to be anywhere near that with the cash rate for a long, long time. And at 0.25, which we're at at the moment, is considered expansionary. So most of the time, in terms of recent contemporary economics, you're going to be asked about. We have an expansionary monetary policy stance because they're trying to stimulate the economy through lowered interest rates. So firstly, to look at the opposite of that, how the RBA can increase interest rates. So if they have a contractionary stance, what that means and how they do it. So firstly, on the first Tuesday of that month, the RBA announces a rise in the cash rate target and provides a detailed explanation of the reasons. If you look this up, it's actually really important for you to look up and read at different points in time. I highly recommend it that if you go onto the RBA website, you can look at their interest rate decisions and there's a list of all the reasons of why they're doing the things they do. It looks at all different indicators. It's really useful information for giving answers about recent economic events. So then they set out to achieve this target by selling government securities at a discounted rate in the short term money market. By selling them at a discounted rate, this means that people are more willing to buy them. So when they buy them, this actually removes money from the money supply. So financial institutions love profit. So they buy these securities from the RBA and this money is exchanged with the RBA for the securities and this reduces the supply of cash in the short term money market. And then the following happens. So we're going to look at the diagram in the next slide. So we've got this here, the supply demand type diagram. So when they want the cash rate to increase for this contractionary stance, they sell government securities and that actually leads selling them. A discounted rate leads for to buy them and that leads to a shift to the left for basically the quantity of cash available. And by doing that, it drives up the cash rate because there's a lower supply of money available overall. Then next up we're going to look at an expansion area, right stance. So the exact same thing, but the opposite. So first the RBA announces that they want to decrease the cash target rate and provides a detailed explanation of their reasons why. They set out to achieve this target by buying back government securities in the short term money market and they're going to buy them at a higher price than they sold them for. So financial institutions love profits, they sell them and so they because they're going to get more in return than they paid for them. And this increases the supply of cash in the short term money market and leads to interest rates falling because there is more money available. How that looks is like this. It's the complete opposite. So by buying back government securities, they're going to increase the supply of cash available and that's going to lead to a favorable shift in the supply of cash and lead to the overall cash rate being driven down in the short term money market. And that's basically it. So essentially it's all about how the RBA tries to manipulate the cash rate by either buying or selling government securities to alter the level of cash available in the economy. If there is more cash available in the short term money market, it decreases the cash rate because when there is more selling available, lowers the price essentially. And when they buy government securities, it takes money out of the short term money market and leads to a higher cash rate because there's less money available and therefore it's more valuable. So more recently, the RBA has been buying back government securities to lower that cash rate to that 0.25 that we currently have and we'll see how it goes for the rest of the year. Will it go lower? Will it stay the same? It's probably going to stay the same, to be honest. But this is what they do to lower the cash rate or increase the cash rate and that's what's called open market operations. So I hope that you've been able to go through this and it makes sense to you. It's relatively simple, step by step. You just need to know that step by step. If you don't totally understand why that happens, follow up, I'll answer some questions, explain why. But it's just those simple step by step leading to that shift to occur and then either the cash rate to lower or to increase. If you have any questions at all, feel free to email me. My email is in the description below. Or send me a message. Whatever. Next up, we are going to be talking about some of the different transmission mechanisms which exist and basically how changes in interest rates affect the economy. On that, I hope you have a wonderful day and I will talk to you next time. Goodbye.