After the Reserve Bank of Australia (RBA) cut the cash rate from 3.5% in September, 2012, to 2.5% by August, 2013, the value of the Australian dollar rose from about 0.89 AUD/USD1 to almost 0.97 AUD/USD over the next two months. On November 21, 2013, Glenn Stevens, the RBA governor said, in regard to a potential monetary intervention aimed at decreasing the value of the Australian dollar:
In this episode so far, the bank has not been convinced that large-scale intervention clearly passed the test of effectiveness versus cost. But, that doesn’t mean we will always avoid intervention. In fact we remain open-minded on the issue.
Why might the Australian dollar have been appreciating in late 2013, despite a recent trend of interest rate cuts by the RBA? Further, under what circumstances could such a statement by the RBA governor be expected to affect the value of the exchange rate? (Hint: You may want to consider the discussion of the carry trade.)
Suppose that you were an advisor to the RBA during this time period. Explain what policy you would recommend. I.e., would you change the cash rate? Would you intervene in the foreign exchange market, and, if so, how? Explain how this policy would affect the Australian economy. Finally, discuss the social and/or cultural impacts of your policy and the degree to which you think these are important in setting monetary policy.