KK4 - Transmission Mechanisms

Question 1

Transmission Mechanisms

Answer 1

How the change in interest rate flows through to the economy

Question 2

Cost of Credit (savings and investment)

Answer 2

The cash rate, interest rate reduces willingness to borrow, increases willingness to save. This causes C and I to decrease. This leads to decreased inflation.

Question 3

Cash Flow channel

Answer 3

Interest rates have a direct impact on individuals or firms with existing loans. As rates change, it effects discretionary funds available to these individuals as they might be forced to repay more money in loans (if not fixed). Decrease in ability to spend more, fall in C, I and AD.

Question 4

The Exchange Rate

Answer 4

Changing interest rates effect return on savings. Increase in interest rates therefore means more foreigners will invest in Australia so as to maximise return on their savings. To do this, they need to change money to AUD, causing an increase in demand of AUD on the foreign exchange market and an increase in exchange rate. This will increase price and decrease demand for exports (fall in AD)

Question 5

Asset Prices Channel

Answer 5

A change in interest rates will impact the value of credit sensitive assets such as property and shares. This will change spending habits of people in these areas. For example, if an investment drops in price, the individual will be less inclined to spend.