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In association with the use of fiscal policy, monetary policy involves action by the Reserve Bank of Australia (RBA)

to influence the cost and availability of money and credit within the economy. Traditionally, monetary policy's objective is to achieve internal balance by influencing the level of interest rates using domestic market operations including the sale and purchase of government bonds, correcting a shortage or surplus of funds respectively, in the short-term money market. To ease or loosen monetary policy, the RBA would buy bonds in order to create excess liquidity, putting downward pressures on interest rates, allowing boosted consumer and investment spending and eventually lower unemployment. Tightening monetary policy in response to increasing inationary pressures would induce the RBA to sell bonds, soaking up funds, and therefore pushing up interest rates to dampen expenditure. Over the course of the business cycle, the RBA will continually tighten and loosen monetary policy in order to prevent ination spilling over its 2-3% average target range. At times, the RBA inuences the exchange rate in order to maintain stability, but without altering the monetary policy stance. This is achieved through sterilized intervention, where the RBA would have to buy or sell bonds equivalent to the amount of $A bought or sold in order to maintain a constant amount of cash, resulting in a constant monetary policy stance.( Dan Nguyen, 2010) Objectives of Monetary Policy The Reserve Bank Board sets interest rates so as to achieve the objectives set out in the Reserve Bank Act 1959. the stability of the currency of Australia; the maintenance of full employment in Australia; and the economic prosperity and welfare of the people of Australia. In fact, the centerpiece of the policy framework is an inflation target, under which the reserve bank sets policy to achieve an inflation rate of 2-3 percent on average, a rate sufficiently low that it does not materially affect economic decisions in the community (Corden, 1994).

The Inflation objective in Australia The inflation objective in Australia is to maintain an average rate of increase in consumer prices, in"underlying terms", of around 2-3 per cent over the medium term. Numbers of that magnitude for average inflation are taken to "equate with reasonable price stability" (Fraser (1994)), in the sense of making any distorting effects of inflation on economic behavior acceptably small. Australia was a low inflation country in the 1960s, enjoying similar average rate of inflation in that decade to Germany. But it suffered high inflation in the 1970s and, for a variety of reasons, less progress was made than in most other countries in reducing inflation in the 1980s. From 1980 to 1989, the average rate of CPI inflation was around 8 per cent. Over recent years

policy has sought to break with this legacy in a decisive way. Inflation was successfully reduced during the early 1990s, amid much public emphasis by the Bank and the Government on the need to make a lasting change in the inflation environment. In contrast to some other countries, which announced targets during the disinflation process, the stronger public focus on a particular number for the inflation objective in Australia came after the big reduction in inflation had been achieved. The ultimate purpose has been the same as elsewhere, however: to condition expectations so as both to help to keep inflation low and to reap as early as possible the gains of low inflation for economic performance.

Kahneman, D., J.L. Knetsch and R. Thaler (1986), "Fairness as a Constraint on Profit Seeking: Entitlements in the Market", American Economic Review, 76, pp 728-741. Fraser, B.W. (1994), Sustainable Growth in Australia, Reserve Bank of Australia Bulletin, July. Selody, J. (1990), The Goal of Price Stability: A Review of the Issues, Bank of Canada Technical Report No. 54. Summers, L. (1991), How Should Long-Term Monetary Policy be Determined?, Journal of Money, Credit and Banking, 23, 3, part 2, August, pp 625-631.