The recent monetary policy response in the US to a positive shock Consider the recent monetary policy response in the world’s largest economy, the United States. It has become evident that the Federal Reserve is serious about reducing the annual rate of inflation which one year ago was 8.2% in September of 2022. Raising the US cash rate quite sharply can be an effective tool at reducing inflation, but this has implications for other advanced economies such as Australia – as pointed out in the following articles (listed in chronological order): • Pupazzoni, Rachel (2022) ‘The Aussie dollar is dropping against the US currency, but it’s not all bad news’, ABC News, October 5th, available: https://www.abc.net.au/news/2022-10-05/usd-aud-exchange-rate/101492848 • Smialek, Jeanna (2022) ‘Inflation Is Unrelenting, Bad News for the Fed and White House’, New York Times, October 14th, available: https://www.nytimes.com/2022/10/13/business/economy/high-inflation.html [Free access, see Reading List on ECON1000 Blackboard site] • Comment on the changes in the Australian dollar as the Reserve Bank of Australia (RBA) followed suit in raising, albeit not as aggressively as the US, its own cash rate. In your answer, provide some data for both countries of the change in the cash rate and the exchange rate (expressed in AUD terms) for two points in time: late-March 2022 and late-October 2022. [300 or so words is the suggested amount for Q3a] 6 marks for quality of analysis and use of data • Use the multiplier AD model and Phillips curve diagram to illustrate and explain in detail how the aggregate demand function in the US economy is expected to shift in a year from now (2023 to 2024) as the Federal Reserve aims to keep long-term inflationary expectations low. In your answer, elaborate in words (no additional figure required) on the different ways in which US households (more vs. less credit-constrained) are expected to respond to such contractionary monetary policy. [500 or so words is the suggested amount for Q3b] 10 marks for quality of analysis, including linked diagrams Apply key economic concepts taught in Modules L3, L4, L7, L8 in ECON1000 TRI2A 2023, and refer to key sentences and ideas from the salient articles to support your analysis – where relevant.
In recent times, the United States has grappled with a high inflation rate of 8.2% in September 2022, prompting the Federal Reserve to take significant measures to address this issue. One of the primary tools used by the Fed to combat inflation is raising the cash rate. This response has implications not only for the US economy but also for other advanced economies, such as Australia. In this essay, we will analyze the changes in the Australian dollar, the Reserve Bank of Australia’s (RBA) response in terms of its cash rate, and the exchange rate between the two countries during late-March 2022 and late-October 2022.
In late-March 2022, the Federal Reserve initiated a series of interest rate hikes in response to rising inflation. The US cash rate increased from 0.25% to 0.5%. Simultaneously, the RBA in Australia decided to raise its cash rate from 0.1% to 0.25%, although it did not follow the aggressive trajectory set by the Federal Reserve.
The impact on exchange rates was significant. The Australian dollar (AUD) depreciated against the US dollar (USD) during this period. In late-March 2022, the exchange rate was approximately 0.72 AUD/USD. By late-October 2022, the exchange rate had fallen to 0.68 AUD/USD. This depreciation in the Australian dollar was due to the interest rate differentials between the two countries. With the US offering higher interest rates, investors flocked to the USD, causing the AUD to weaken.
The Australian economy, being heavily reliant on commodity exports, also felt the pressure from the stronger USD. A weaker AUD made Australian exports more competitive, but it also increased the cost of imports, potentially fueling domestic inflation.
The RBA’s approach was more cautious compared to the Federal Reserve, reflecting the differences in the economic conditions of the two countries. Australia had relatively lower inflation and was cautious not to slow down economic growth significantly, whereas the US had a more pressing need to combat inflation.
To understand how the Federal Reserve’s monetary policy response is expected to affect the US economy in 2023-2024, we can employ the Aggregate Demand (AD) model and the Phillips Curve diagram.
The AD model suggests that as the Fed raises interest rates (i.e., tightens monetary policy), it reduces consumer and business borrowing due to higher borrowing costs. This, in turn, lowers consumer spending and business investments, causing a leftward shift in the AD curve.
In 2023-2024, this shift in the AD curve is expected to result in a decrease in economic growth, potentially leading to a slowdown in the rate of inflation. The Fed’s aim is to keep long-term inflation expectations low. This contractionary monetary policy will likely have varying effects on US households.
Households that are more credit-constrained, meaning they rely on borrowing for consumption and investment, will be more adversely affected. Higher interest rates will increase the cost of servicing debt, leaving them with less disposable income for spending. Consequently, they are expected to reduce their consumption, causing a sharper decline in aggregate demand.
On the other hand, households that are less credit-constrained, possessing substantial savings and minimal debt, will be less affected by rising interest rates. They may continue to spend, although perhaps at a slightly reduced rate due to the overall economic uncertainty. However, this group is better positioned to weather the monetary policy changes.
The recent monetary policy response in the US to combat high inflation has had ripple effects on the Australian economy and the exchange rate between the two countries. The Federal Reserve’s decision to raise the cash rate was mirrored, albeit less aggressively, by the RBA. The resulting depreciation of the Australian dollar affected trade balances and inflation dynamics in Australia.
Looking forward to 2023-2024, the contractionary monetary policy in the US is expected to shift the aggregate demand function to the left, leading to a potential slowdown in economic growth and a reduction in inflation. The impact on US households will vary, with more credit-constrained households likely to experience a greater reduction in consumption. These changes in monetary policy and their consequences underscore the interconnectedness of the global economy and the importance of central banks’ actions in managing inflation and economic growth.
As a renowned provider of the best writing services, we have selected unique features which we offer to our customers as their guarantees that will make your user experience stress-free.
Unlike other companies, our money-back guarantee ensures the safety of our customers' money. For whatever reason, the customer may request a refund; our support team assesses the ground on which the refund is requested and processes it instantly. However, our customers are lucky as they have the least chances to experience this as we are always prepared to serve you with the best.
Plagiarism is the worst academic offense that is highly punishable by all educational institutions. It's for this reason that Peachy Tutors does not condone any plagiarism. We use advanced plagiarism detection software that ensures there are no chances of similarity on your papers.
Sometimes your professor may be a little bit stubborn and needs some changes made on your paper, or you might need some customization done. All at your service, we will work on your revision till you are satisfied with the quality of work. All for Free!
We take our client's confidentiality as our highest priority; thus, we never share our client's information with third parties. Our company uses the standard encryption technology to store data and only uses trusted payment gateways.
Anytime you order your paper with us, be assured of the paper quality. Our tutors are highly skilled in researching and writing quality content that is relevant to the paper instructions and presented professionally. This makes us the best in the industry as our tutors can handle any type of paper despite its complexity.
Recent Comments