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| Question | Answer |
| What is Monetary Policy? | Refers to the interest rate decisions taken by the RBA to affect monetary and financial conditions within the economy, with the aim of achieving low inflation and sustainable economic growth. |
| What are financial markets? | They are an intermediary between savers and investors, or lenders and borrowers of funds. |
| What are the 3 main types of financial markets? | 1. Loan markets 2. Bond markets 3. Share markets |
| What are loan markets? | Where businesses and firms borrow money to buy capital equipment while households borrow for housing and cars. |
| Who are involved in loan markets? | Banks, finance companies and credit unions. |
| What are bond markets? | Where firms and governments sell bonds to raise finance. |
| What is a bond? | A fixed interest security, the main method by which governments fund a budget deficit. |
| What are share markets? | Where firms can obtain finance for expansion by issuing new shares through the stock market. |
| How is does investment come about through savings? | Money and credit facilitate transactions between buyers and sellers. This enables the savings of the sellers to be converted into investment by the buyers. |
| What are the 3 key functions of money? | 1. Means of exchange 2. Unit of measurement 3. Store of value |
| What erodes the value of money? | Excessive inflation. It also reduces the ability of money to perform its key functions. RBA GOAL OF PRICE STABILITY |
| Why is the financial sector important? | It is linked to every sector in the economy. A stable financial sector is a key ingredient to sustainable economic growth. |
| What do interest rates represent? | The price of credit -- a payment from borrowers to lenders for the use of funds. |
| What does interest represent? | The cost of borrowing money over a period of time. Opportunity cost / price of money. |
| What do interest rates also represent? | The reward for saving -- the return people get for not spending. |
| What effect can interest rates have on the economy? | They have a significant effect on the level of spending and economic activity. |
| What are nominal interest rates? | Interest rates not adjusted for inflation. |
| What are real interest rates? | The nominal interest rates minus the rate of inflation. |
| What interest rates have an important influence in economic decisions involving borrowing and saving? | Real interest rates. These show how much borrowers actually pay and how much lenders receive in terms of purchasing power. |
| What do borrowers and lenders each prefer? | Borrowers - low interest rates. Lenders - high interest rates. |
| What do the nomial interest rates reflect? | They reflect the inflation rate. If inflation increases, then nominal interest rates will rise as well. |
| Why do interest rates vary? | According to 1. Risk 2. Time |
| Why is there risk? | Because the future is uncertain. If a loan is made for a purpose which has a higher level of uncertainty surrounding the repayment of the money, the interest rate charged will be higher. |
| Why is time important? | Longer term interest rates are higher than shorter term. Lenders need to be compensated for parting with their funds over a longer period -- also greater risk and greater uncertainty. |
| What is the market for loanable funds? | The market in which savers supply fund and investors borrow funds. |
| What are the loan, bond and share markets classed as? | The market for loanable funds. |
| What is the demand for loanable funds? (DLF) | The quantity of funds demanded for investment by the private sector and the government. |
| What relationship is seen between the DLF and real interest rates? | Negative relationship -- the higher the real rate of interest, the lower the demand for funds. |
| What is the supply of loanable funds? (SLF) | The quantity of loanable funds supplied to the market. |
| What is the main source of loanable funds? | Savings -- private savings by households and firms. Government saving from budget surpluses. |
| What relationship is seen between the SLF and real interest rates? | Positive relationship - as the rate of interest rises, the quantity of loanable funds supplied will increase. Higher interest rates are an incentive to save. |
| What causes real interest rates to fluctuate? | The market forces of demand and supply. The level and movement of interest rates will reflect conditions in both the domestic and global economy. |
| What factors cause the demand and supply curve to shift? | Increase IR: increase in demand or a decrease in supply Decrease IR: decrease in demand or increase in supply. |
| INCREASE IN REAL INTEREST RATES What factors could increase the DLF? | 1. An increase in economic activity. 2. A government budget deficit. |
| INCREASE IN REAL INTEREST RATES What factors could decrease the SLF? | A decrease in private savings. |
| DECREASE IN REAL INTEREST RATES What factors could decrease the DLF? | A decrease in economy activity. |
| DECREASE IN REAL INTEREST RATES What factors could increase the SLF? | 1. A government budget surplus. 2. An increase in private savings. |
| What is the aim of monetary policy? | To help achieve sustainable growth in the long run by controlling inflation. |
| What does inflation do? | Reduces the value of money an undermines the confidence of households and firms. |
| What effect does high inflation have? | Negative effect on economic growth and living standards. |
| What are the objectives of monetary policy? | 1. Price stability 2. Full employment 3. Economic prosperity and welfare |
| What is the most important objective and why? | Price stability -- low inflation helps to achieve the second objective of low unemployment. Promotes business confidence and encourages investment - increases economic growth. |
| What is stagflation? | High cost inflation -- associated with a rise in unemployment and a stagnant economy. |
| What does inflation lead to? | Higher interest rates which reduces private sector spending and lowers economic growth. Also reduces international competitiveness. |
| What effect does price stability have? | Low rate of unemployment and rising economic prosperity can be achieved. -Low inflation helps businesses make sound investment decisions and encourages employment growth and preserves the value of money. PROTECTS PEOPLE'S SAVINGS. |
| How can inflation be measured? | 1. Headline inflation 2. Underlying inflation |
| How is the headline inflation rate measured? | Measured using the consumer price index (CPI). Most commonly used measure of inflation. |
| How is the underlying inflation rate measured? | Measured using the headline inflation minus the volatile and seasonal elements. Meant to provide a more accurate measure of inflation. |
| What measure do economist prefer to use? | Underlying inflation because the headline inflation numbers can be misleading due to certain volatile categories. |
| How is monetary policy implemented? | 1. Through the money supply. 2. Through interest rates. |
| How is monetary policy conducted? | Through changing the short term interest rates. Through domestic market operations with financial institutions in the short term money market. |
| What is the tool of monetary policy? | Cash rate. Determined by the demand and supply of overnight funds between institutions and the RBA. |
| What are open market operations? | The buying or selling of Australian government securities. |
| How does the RBA tighten monetary policy? | Through entering the money market and creating a shortage of cash by selling securities. This increases the price of cash - cash rate - and will cause other short & long term interest rates to rise. |
| What happens to: 1. The cost of borrowing 2. The demand for credit 3. Spending 4. Economic activity | 1. Rises 2. Falls 3. Contracts 4. Contracts |
| How does the RBA loosen monetary policy? | Use market operations to create a surplus of cash by buying securities. This will reduce the price of cash and place downward pressure on interest rates charged on loans. |
| What happens to: 1. The cost of borrowing 2. The demand for credit 3. Spending 4. Economic activity | 1. Falls 2. Rises 3. Expands 4. Expands |
| What is the transmission mechanism? | Describes how changes in interest rates affect the level of economic activity in the economy. |
| T | |
| What will a change in the cash rate do? | Change other interest rates. This leads to changes in private spending which affects output, employment and prices. |
| What do changes in interest rates affect? | - saving and investment decisions - cash flow of households and firms - wealth and asset prices - exchange rate |
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