Why Monetary Policy Transmission Affects Economy Wide...

The RBA conducts monetary policy either by a contractionary policy, raising interest rates to fight high levels of inflation or an expansionary policy, reducing real interest rates to fight recession. The inverse relationship between real interest rates and household consumption as presumed by Keynesian model means, implementing either monetary policies will resolve in a transmission mechanism to interest rates and affect several components of PAE. How the overnight cash rate is successfully targeted and how this affects economy wide interest rates will be explained as well as a list underlying forces will be provided illustrating why monetary policy transmission channel fail to work. a) Keynesian model presumes an inverse relationship between real interest rate and household consumption expenditure which partly justifies the monetary easing policy to fend off economic weakness in recession periods. Please describe the transmission mechanism of interest rate through the economy in general. Which components of PAE are affected by changes in interest rates and how? (20 marks) The transmission mechanism of interest rates begins with the RBA either increasing, or decreasing the overnight cash rate as (Kent 2015) mentions. This leads Financial markets to make changes to the future path of cash rates and the structure of deposits and lending rates. These changes then transmit their ways to aggregate demand, affecting several components of the PAE. (Diagram A) illustrates aShow MoreRelatedBanking, Money and Finance, Article Analysis Essay1520 Words   |  7 Pagesdiscussing of bank deposits and loans in the monetary transmission mechanism. It would lead the financial system to achieve monetary stability and creation of sound financial structure. 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