Paper on Navigating Deflation: Australia's Response to Rising Real Interest Rates and Monetary Policies

The article talks about the rise in the real interest rates in Australia as deflation emerges in the economy. Deflation reduces the general price levels of goods and services and results from a negative inflation rate. Australia suffers from a sudden deflationary shock as a modern economy as this increases the real value of debt, especially when the deflation is unexpected. The result is a reduction in the spending power of consumers and firms. The core measures strip out the price volatility, causing it to turn negative every quarter. The demand and supply of money determine the interest rates offered by financial institutions. The abrupt deflation in Australia can be attributed to an increase in the supply and production processes, followed by low demand for the products resulting in net capital outflow in the economy.

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The effects of deflation are evident from the decreasing consumer prices by 1.9% in the three months, and negative price volatility every quarter. To control the effects of deflation, the Central Bank of Australia embraces expansionary monetary policies to decrease interest rates and increase consumption and investment, thereby increasing aggregate demand. Such processes would help to close the deflationary of recessionary gaps.

Interest rates play a vital role in controlling the supply and demand for money. To control deflation, the Central Bank of Australia applies mechanisms to increase its economic consumption by establishing the means to increase aggregate demand in light of the present uncertain economic conditions. This can be done by increasing the demand and supply of money causing it to shift from S1Q1 to S2Q2. The resultant effect of the move is a reduction in the rising real interest rates in the Australian market from r1 to r2.

According to the article, the measures implemented by the central bank, i.e., a reduction of its cash rate and three-year yield target to 0.10% from the current 0.25%, would help to increase the supply of money to the economy and increase the demand for goods and services, in a bid to control deflation and its effects (Heath). The effect of the reduced cash rate is a low long-term yield from the traditional QE launched by the local banks. While the interest rates may not seem like a feasible constraint to the willingness and capacity of people to borrow, the weak aggregate demand and economic uncertainty experienced by companies during the pandemic are factors that have to be addressed. The interest rates can not go below zero, therefore the deflation would result in a consequent and equal increase in the real interest rate, thus calling for a tightening of the monetary policies.

Other measures such as quantitative easing can also be used by the central bank through buying government bonds and other financial assets to inject money into the economy and encourage more economic activity in the region. The main macroeconomic objective is to reach the target inflation rate (as opposed to full employment). The main objectives of the monetary policies implemented by the Australian government resonate around reaching and maintaining the inflation rate. Such expansionary monetary policy measures would enable the Reserve Bank of Australia to provide easier credit conditions that will enable the economy to recover from the effects of the Coronavirus pandemic.

Works Cited

Heath, Michael. Australia's Real Interest Rates Rise in a challenge for the central bank. Bloombergquint.com, 2020. www.bloombergquint.com/global-economics/australia-real-interest-rates-rise-in-challenge-for-central-bank