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Question 2 (monetary policy)The RBA made the following statement in their October Financial Stability Review: “With...

Question 2 (monetary policy)The RBA made the following statement in their October Financial Stability Review:
“With economies experiencing large contractions in output, the focus has shifted from liquidity to the
solvency of borrowers as expected defaults will result in credit losses for lenders. The global economic
recovery is going to take time and will be uneven. Its path is also highly uncertain, and dependent on
the further course of the virus. Risks to financial systems will therefore remain elevated for some time
to come.”
What do you think will happen to interest rates in the short-term to medium term in Australia and
globally? In answering this question, you need to include the following (these are suggested minimums.
Do not restrict yourself to only these points):
(i) What you understand monetary policy to mean?
(ii) The role of central banks in monetary policy
(iii) How interest rates affect households and other sectors of the economy.

Solutions

Expert Solution

1. The Monetary Policy here means rather than creating a higher liquidity in the economic sysytem need is to secure the income of people through salary subsidies and other such measures. Such measures will provide a support to the people and they will be in a position to pay their loans once the condition improves. The government around the world are following such Non- Traditional policies of securing jobs & business through subsidies to safeguard and stimulate economic activities.

If this is not done borrowers may default leading to heavy economic losses to financial sytem. This may lead to panic and distress in the economy which may ignite sale of assets at lower prices.

As per the current monetary policy Banks must deal with the borrowers who may not resume repayment in near future.This will avoid losses to banks, protect borrower and spillover of collaterals.

But this policy will increase the Government's debt. Central banks around the world including Australia will keep short term interests low & will cap intermediate interest rates also. So as Debt-to-GDP ratios are expected to be significantly higher even after the pandemic passes, monetary plicy should be such which helps the governments to deal with such heavy debt.Moreover history of pandemic shows that real interest rates have remained low for over decades after the pandemic.

Lowering interests are said to dcreased savings among households. But It will not be a case now, as people will tend to save more and create lost wealth.Firms will be able to initiate business activities only if capital is available at lower cost. So in my view interest rates will remain low in short and medium run.


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