Title: Financial market innovation in Australia: implications for the conduct of monetary policy
Abstract: economic growth while also supporting the longer-term growth prospects of the economy. 1 Whether financial innovations have facilitated the conduct of monetary policy, however, is less clear cut. Some innovations may have supported or encouraged households and businesses to increase the amount of debt owing – this increase in the share of income going to interest payments would tend to make these sectors relatively more sensitive to changes in monetary policy. At the same time, the compression in margins between borrowing and lending rates may have changed how any particular level of the policy interest rate could be associated with a particular stance of monetary policy. In other words, it may affect our views about what is the appropriate level of the policy rate. Moreover, where links between markets have been strengthened by financial innovation, a shock in one market may be more easily transmitted to other markets. This increasing interdependence poses new challenges for policy makers. 2 Problems in the US sub-prime loan market are now reverberating through many countries. In Australia’s case, for instance, this has temporarily choked off investors’ demand for new issues of Australian residential mortgage-backed securities (RMBS), and short-term asset-backed commercial paper (ABCP). For those institutions reliant upon such wholesale markets for the bulk of their funds, this may represent a serious risk to their long-term survival. More generally, it has triggered a sharp repricing of risk which, if sustained, will eventually flow through into higher rates for both households and businesses. This paper is in two parts. The first looks at several recent financial innovations that have had a significant impact upon the Australian financial system. We provide some background to their origin and then look at their impact upon the conduct of monetary policy. We examine the impacts of securitisation, the rise of mortgage brokers and the development of swap markets, particularly cross currency swaps. The latter part of the paper takes a somewhat longer-term perspective and looks at how secular changes in financial markets have affected the Reserve Bank’s monetary policy operations. In particular, it examines how the Bank has needed to reshape its monetary operations in the face of a declining supply of Commonwealth Government Securities (CGS), which traditionally had been its domestic riskfree asset of choice.
Publication Year: 2008
Publication Date: 2008-01-01
Language: en
Type: preprint
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Cited By Count: 4
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