According to Edirisuriya (2010, 5), monetary policy is the regulation of the monetary supply and interest rates by a central bank so as to counter inflation and make the local currency more stable. Monetary policy refers to the actions and policies initiated by a country, through its central bank or through other government regulatory authorities to control the supply and flow of money in the economy. Monetary policies impact the economy in terms of short term interest rates, inflation rates and liquidity in the domestic country.
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As per the theoretical model of money supply and inflation, increases in money supply in an economy will lead to inflationary pressures. An expansionary monetary policy is meant to help grow a country’s economy. Expansionary policies increase money supply in the economy through government investment programs, which usually leads to inflationary pressures.
Monetary policies are not always enough in the maintenance of stable inflation levels because the inflation rates may also be influenced by changes to the global economy. For instance the oil crisis in 1970 and the recent financial crisis and global recession in 2008 influenced almost all economies in the world (Kidwell, Brimble, Beal and Willis 2007, 56).
Australia and the Hong Kong monetary policy
Australian monetary policy
In Australia, the Reserve Bank of Australia is in charge of inventing and putting into practice the monetary policy. Monetary policy resolutions engage setting the interest rates on overnight advances in the money market. Other interest rates in the economy are influenced by these interest rates to varying levels, so that the actions of those borrowing and lending in the financial markets is influenced by monetary policy, although maybe by other factors.
The objectives of the monetary policy are to attain the “goals set forth in the Reserve Bank Act 1959, which are; stabilise the Australian currency; maintain full employment in the country; and ensure economic development and welfare of the Australian people” (Hunt and Terry 2008, 19).
The primary medium-term goal of the Australian monetary policy is to counter inflation, so an inflation mark is therefore the focus of the monetary policy approach. “The Governor and the Treasurer have concurred that the appropriate target for monetary policy is to attain an inflation rate of 2 to 3%, on average, over the cycle” (Hunt and Terry 2008, 24).
This is a rate of inflation adequately low that it doesn’t significantly deform economic decisions in the society in quest to attain this rate, on average, gives discipline for monetary policy decision making, and acts as a pivot for private sector inflation anticipations.
Over the past decade, the monetary-policy structure in Australia has changed significantly. Currently, Australia uses an inflation-targeting approach to monetary policy. The inflation target is explained as a medium term average instead of a rate, which should be held at any given time. This formulation gives room for any expected in eventualities, which are entailed in predicting, and snarls in the impacts of the monetary policy on the economy.
Occurrence in Australia and all over the world has proven that inflation is hard to fine tune given a tapered band. The inflation target is also, essentially, positive and optimistic. This framework allows responsibility for monetary policy in countering the variations in output over the ongoing of the business cycle. When collective demand in the economy is low, monetary policy can be eased that will provide a short term stimulus to economic action (Canova and Pappa 2007, 727; Lewis and Wallace 1997, 39).
The principal responsibility of the Australian monetary policy is the open markets operation. This involves controlling the amount of money in distribution in the economy through the trade of the different financial instruments, for example government bonds, company bonds, treasury paper and forex exchange. This trade leads to more or less base currency inflowing or out flowing in the market. However, normally the short-term objective of open markets operation is to attain a certain short-term interest rate standard level.
In other cases, monetary policies might rather involve the aiming of a particular currency exchange rate comparative to some overseas currencies or else comparative to valuable metals. Whenever a fiscal deficit is high, the government demand for debt funding will decrease the amounts of money available in the economy as capital investment in the private sector and hence limiting economic development (Edirisuriya 2010, 56).
In Australia, “the central bank adjusts the official cash rate so as to assist keep inflation within sustainable levels. The International Monetary Fund argues that in order to allow more policy “room” at the time of crises, an economy needs to set a higher inflation target” (Reserve Bank of Australia 2011).
The Reserve Bank of Australia applies an inflationary range of 2 to 3 percent as its reference when coming up with monetary policy resolutions. Thus, the Reserve Bank uses interest rates so as to calm an overheating economy (by increasing the cash rate) or to pace up a snarling economy (by reducing the cash rates).
Flow of the cash rate is fast fed through to other capital markets interest rates, for example money market rates and bond yields. These interest rates are also affected by the risk forbearance of depositors and shareholders and utility for holding their funds in a form that they are easily exchangeable.
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“The cash rate and other capital markets interest rates then passed through to the whole framework of depositing and loaning rates. In Australia, most deposits and loans are at variable or short term fixed rates, therefore there is a high pass through of variances in the cash rate to depositing and lending rates” (CPDS, 2011).
Nevertheless, because of the other aspects affecting capital markets rates, and variations in the degree of competition in the banking sector, deposits and lending rates do not always change directly with the cash rate. Nevertheless, Australia’s monetary policy is one of the most liberal approaches worldwide today, with many other nations struggling with an inflationary range of between 1 and 2 percent (Valentine, Ford, Edwards, Sundmacher and Copp 2006, 124).
The strength of the Australian monetary policy can be better seen in the way Australia rode out the 2007-2008 global financial crisis. It was far much better than most other countries.
At the time of the financial crisis, Australia could not escape the wrath of the economic crisis because; at the time, Australia was ongoing into an acute shortage of capital that made it be at risk – particularly if property values went down; safeguard against a financial crisis would be ineffective due to lack of serious international attempts to solve ongoing worldwide macro-economic issues; in addition, there were practical limitations on essentially mounting foreseen protection.
However in 2009, the federal government responded to the risk and pumped in a $42 billion package to increase spending and payment to individuals to increase demand. This in a way adequately addressed the symptoms of the failure of the GFC (that is, the distortion of the economy).
Monetary policy in Hong Kong
The government of Hong Kong is directly responsible for formulating monetary and fiscal policies according to Article 110 of the Basic Law (Osborne 2007). Therefore, there isn’t any external control from either Main Land China or PBoC thus leaving the Hong Kong Government fully autonomous on its monetary policies. Hong Kong monetary policy mandate is to maintain currency and economic stability in the region.
Due to the fact that Hong Kong’s economy is externally oriented, the HKMA is obligated to have a stable exchange rate against foreign exchange markets. “The currency board arrangements, requires the Hong Kong dollar monetary base to be at least 100 per cent backed by, and changes in it to be 100 per cent matched by corresponding changes in US dollar reserves held in the Exchange Fund at the fixed exchange rate of HK$7.80 to US$1” (HKMA, 2011).
The stability of the Hong Kong Dollar is maintained through a system known as the “interest rate adjustment Mechanism”. The monetary policy is therefore formulated and implemented by the Hong Kong’s central bank. It stabilizes the economy by further adjusting the interests’ rates and money supply just like it did during the 2008 recession especially, given the fact that price stability for vital items such as oil is the main target of the central bank when adjusting interest rates and money supply (HKMA, 2011).
Since the introduction of the fixed exchange rate, note issuing financial institutions has been required have certificates of indebtedness which are issued by the Hongs Kong’s Exchange Fund which acts as a backup for the bank note issuance which are usually made against the US dollar.
“The expansion or contraction in the monetary base leads interest rates for the domestic currency to fall or rise, respectively, creating the monetary conditions that automatically counteract the original capital movements, ensuring stability of the exchange rate” (HongKong2004, 2011).
Hong Kong Monetary policy dictates that there be a fixed exchange rate against the dollar, though a lot of debates have emerged over this issue, Hong Kong has continued to prosper economically due to this policy. The economic prosperity is due to the transparent and dependable monetary discipline that is associated with the currency exchange rate.
In addition, this exchange rate has also influenced the interest rates especially in the just past recession. The Hong Kong’s policy of a fixed exchange rate made it avert serious economical crises in Hong Kong which would have resulted in further economy depreciations and damage to the region’s economy (Mishkin and Eakins 2006, 56).
However in 2008, Hong Kong slid in the global recession thereby joining other global economies that were experiencing the same issue. Due to the recession, its GDP fell by 0.4 percent thereby derailing the economy of the region.
In order to control recession and have a stable economy, the Hong Kong monetary policy is keen on having a transparent policy that will ensure that the financial sector and the public in general is quite aware of the functions of the currency board that is charged with implementing the Hong Kong’s monetary policy.
In order to achieve this, the board the board publishes its currency accounts on a monthly basis. Furthermore, the Hong Kong Government fully supports the continuous interrelation of the linked exchange rate system that is the keystone to Hong Kong’s Monetary and fiscal stability.
Comparison and contrast between the two monetary policies
Both Australia and Hong Kong use open market operations to impose control over monetary supply. Open market operation involves the buying and selling of government treasury bonds and papers. Primarily, the short term objectives for open market operation are specified by the currency board system. These objectives are often to attain a specific level of currency reserves or a given interest rate (Anonymous 2011).
Unlike Australia, Hong Kong uses a pegged exchange rate system that adjusts the exchange rate of Hong Kong Dollar; this means that the Hong Kong Monetary Authority does not dictate the monetary supply.
Because under the currency board system, monetary supply is determined by market forces of demand and supply, the market demand exclusively depends on the flow of capital, that is, the inflow or outflow of capital would direct to an adjustments in the interest rates rather than the exchange rate. For instance, when there is an inflow of capital into the financial system, the currency foot would rise.
However, the issue reverses when there is an outflow of capital. According to the pegged exchange rate system, the currency board cannot determine the interest rates independently or alter the exchange rates; hence it does not have the privilege to formulate monetary policies.
Indeed, the current financial system ensures the authority does not print as many bank notes as it would like, hence lowering the likelihood of inflation. Currently, Australia has a flexible exchange rate system against all currencies making it one of the most liberal currency markets in the world (HK gov. 2011).
In Australia, the Governor and Treasurer are responsible for formulating the monetary policy objectives and monetary system, while in Hong Kong the HKMA has to attain the monetary policy goals on its own, this could include finding out related approaches, instruments and ways of implementation, to make sure the stability and reliability of the financial system of Hong Kong.
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