Australia's Approach to Monetary Policy

Article excerpt

According to Australia's Reserve Bank Act, the central bank's broad policy objectives include maintaining the stability of the currency, full employment, and the economic prosperity and welfare of the people of Australia. In 1993 the Reserve Bank of Australia adopted a specific, and thus transparent, inflation target as its operating objective; it aims to keep overall inflation (1) between 2 percent and 3 percent on average over the business cycle.

The Reserve Bank of Australia (RBA) is accountable directly to the Parliament and, through Parliament, to the general public. The Reserve Bank Act (1959) requires the Bank's Board to provide an annual report on its operations and finances to the Treasurer and to Parliament. A 1996 "Statement on the Conduct of Monetary Policy," issued jointly by the Governor of the Bank and the Treasurer, clarifies the respective roles of the Bank and the government in regard to monetary policy and provides formal government endorsement of the Bank's inflation objective. It also outlines a procedure for the Governor to appear before the House of Representatives Standing Committee on Economics, Financial Institutions, and Public Administration twice a year to report on its conduct of monetary policy. In the event of a disagreement between the Government and the Bank's Board on policy issues, the Reserve Bank Act lays out the procedures to be followed. They have never been used, and formal and informal contacts between the Bank , the Treasury, and other government departments are frequent.

Central Bank Assets

At the end of June 2001, the Reserve Bank of Australia held assets equaling $A58 billion, of which 62 percent were in foreign exchange and 2 percent in gold. Government securities (of which the majority were securities sold under repurchase agreements) comprised 8 percent, while loans, advances and bills held (including securities bought under repurchase agreements), and clearing items made up 26 percent.

Since the Bank began announcing its policy changes in 1990, the desired stance of monetary policy has been expressed in terms of the operating target for the cash rate, the money market rate on overnight interbank funds. Because the Australian system operates without reserve requirements, the banks' demand for overnight funds stems from their need for settlement balances, which are held as exchange settlement (ES) accounts at the Reserve Bank. Each bank is required to have a positive balance in its ES account at all times. Through its daily open market operations, the Reserve Bank adjusts the supply of funds to keep the cash rate close to its target.

Open Market Operations

Although, with minor exceptions, only banks have ES accounts, the Reserve Bank of Australia is now willing to deal with all major financial institutions, both bank and nonbank, that are members of the Reserve Bank Information and Transfer System (RITS), an electronic system for the settlement of large-value cash and Commonwealth Government Securities (CGS) transactions. (2) Currently, PITS has 137 members--54 banks, 3 special service providers, and 80 nonbanks--but in practice the Bank deals regularly with around a dozen institutions. The Bank conducts two types of transactions. It may buy (sell) outright CGSs of less than about eighteen months to maturity. It also accepts CGS, state and territory Commonwealth government, and certain supranational securities in repurchase agreements. In fact, 80 percent of open market transactions take the form of repos. The average maturity of the repo book has lengthened in recent years from two days in the mid-1990s to 12 days in 2000-01. In addition--and to an increasing extent-- the Reserve Bank may choose to do a foreign exchange swap (basically a repo, with both a spot delivery and an agreement for future reversal, based on foreign exchange rather than securities) for purposes relating to liquidity management rather than to exchange rate stabilization. …