Monetary policy Essay Example | Topics and Well Written Essays - 1250 words

Monetary policy - Essay ExampleThe RBA often determines the official cash in dictate aft(prenominal) deciding on what monetary policy target it intends to attain (Reserve Bank of Australia, 2012a). Such targets may include, change magnitude economic growth, lowering inflation. RBA uses open grocery store operations to affect the changes of the official cash rate, which in turn away trickles down to the financial system in the country. Although RBA changes the official cash rate through open mart operations, the actual cash rates are often determined by supply and necessary actions among banks. distributively bank is free to determine the rate by which it supplys to an other(a) bank. Changing the official cash rate however, impacts all other interest rates in the commercialise place which in turn impacts the supply and demand of money in the economic system (Reserve Bank of Australia, 2012b Lowe, 19951-2). The market rate of interest on the other hand is the rate that financ ial institutions charge its clients for borrowing money. This interest is often impacted by changes in the official cash rate, whereby increases in cash rate would imply that the banks are borrowing from other banks expensively and hence would in any case increase the interest rate that they charge their customers for borrowing money. A drop in the official cash rate would make it cheaper for the banks to borrow gold and hence competition among banks would reduce the market interest rate across the Australian Economy (Smales, 201152-55). The RBA decreases the cash rate through open market operations in order to ensure that the official cash rate that has been set is as reason as viable to the actual cash rate exhibited in the market due to forces of demand and supply. from each one financial institution in the country has an Exchange settlement account for which enable banks to settle payments mingled with each and also with the RBA. Where RBA wants to reduce the cash rate, it would buy repurchase agreements (repos) or second-hand common wealth political science securities (CGS) from the financial institutions in the economy. The RBA pays the banks using their exchange settlement accounts with the RBA which increases the amount that they have access to and can lend out (Reserve Bank of Australia, 2012b Kuttner and Mosser, 2002 16). This increases the supply of money in the economy, and due to competition to lend out to borrowers, the cash rate as well as the market interest rates drop. This is as demonstrated in a simple Keynesian model below As noted in the figure, when the RBA uses the open market mechanism to purchase government securities and repos, the money supply denoted by MS, moves from the original position MS to MS1 present a rise in money supply. Since the supply money is inelastic relative to interest rates, the MS curve is perfectly inelastic. On the other hand, the demand for money changes with changes in interest rate. Hence as money sup ply increases in volume due to RBA purchasing repos and CGS, interest rates fall also drop. Answer two Effect of a decrease of interest rate on Consumption and investment expenditures a fall interest rates increases investment and consumption. As noted above, a fall in interest rates is as a result in an increase in money supply. This makes it possible for businesses and consumers increase their borrowing from banks at a lower rate of interest since it is cheaper to access loans. Hence, there would be an increase in consumption and investment expenditures financed by debt as businesses are able to access funds for capital goods such as equipments, and consumers are also able