KK2, KK3 - Conventional Monetary Policy, Role of the RBA

Question 1

Monetary Policy

Answer 1

Monetary policy is a branch of macroeconomic policy operated by the RBA and designed to regulate the level of AD and economic activity. It relies most heavily on changes in interest rates to alter the cost, availability and demand for credit (borrowed money)

Question 2

Interest Rates

Answer 2

The annual cost of borrowing credit or the annual return on invested savings.

Question 3

Short Term Money Market (STMM)

Answer 3

a specialist financial market where credit is borrowed and lent for short periods. In this market, RBA market operations affect the supply of cash and, in so doing, influence the cash rate. The RBA use the principles of supply and demand to manipulate the short term money market in order to raise or reduce interest rates.

Question 4

STMM graphed

Answer 4

The interest rate = The ‘equilibrium’ price for cash
Demand = The people who want to borrow money
Supply = Banks and other financial lenders whose supply is ultimately controlled by the Reserve Bank of Australia

Question 5

Government securities/ bonds

Answer 5

These are debt products issued by the government. It is a promise to pay. The holder of the bond becomes the lender of money to the issuer.
Buying bond = loaning (giving money)
Selling bond = borrowing (taking money)

Question 6

Exchange settlement accounts

Answer 6

These are accounts held with the RBA by every major banking organisation and are mainly used to facilitate transactions between customers of different institutions. (Must be positive each day).

Question 7

Open Market Operations – Increasing Cash Rate

Answer 7

When the RBA wish to increase cash rate it will move to decrease the amount of cash in the short term money market by selling government securities in to the market.

Question 8

Open Market Operations -Decreasing the Cash Rate

Answer 8

When the RBA wish to decrease in the cash rate it will move to increase the amount of cash in the short term money market by purchasing government securities in to the market.

Question 9

Note

Answer 9

The RBA does not have the ability to simply ‘change’ the cash rate. They must alter the supply of money in order to ‘target’ a cash rate.

Question 10

Target Cash Rate

Answer 10

The RBA typically sets the target cash rate at the centre of a corridor that includes the setting of a ceiling and floor within which borrowing and lending by all banks must occur.