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Short Essay RBA

Explain how and why the Reserve Bank can inuence the interest rates and economic activity- 500 words The Reserve Bank of Australia (RBA) has a signicant impact on the interest rates, and hence the economic activity occurring in Australia, and does so for numerous reasons. The RBA is the central bank and monetary authority in Australia, and thus has inuence over the operation of money and its effects on the Australian economy. Monetary policy one of the instruments used by the RBA to inuence the short term interest rate, known as the cash rate. The cash rate will affect the interest rates for different things across the economy, and is set by looking at the supply and demand in the economy and how the RBA wishes to inuence these factors. The RBA is allowed to inuence interest rates as the central bank for Australia for a general goal of ensuring economic security. The RBA has control over the cash rate to control the cost and availability of funds in the Australian money market, which will determine the amount of investment in the economy to achieve desired outcomes such as growth if growth is needed or vice versa. It can also inuence interest rates to try and control the ination rate but at the same time encourage growth, so that the economy can grow at a sustainable rate, and nally, to try and avoid nancial crisis from entering our economy, so that people will continue to invest and spend and protect the funds of investors in the Australian economy. The RBA can control the cash rate by buying and selling securities to bank exchange settlement accounts to inuence the amount of money they have to lend. If the RBA sells these securities, banks will have less borrowable funds available, meaning the cash rate will increase, and banks will increase their marginal interest rates; borrowers then will pay more on their current loans and it will be harder for new borrowers to borrow theses funds, meaning investment and consumption fall as the demand for funds decreases, shown in the below graph, as at the higher interest rate of point 1, there is less quantity of funds demanded then at point 2, leading to a decrease in economic activity and the economy will move towards a contraction.

P1 P2

Diagram 1 On the other hand, if the RBA buys securities, banks will have an excess of borrowable funds in their exchange settlement accounts, which will cause the cash rate to fall and marginal interest rates will fall so that the banks can lend out all their funds, meaning borrowers will demand funds, shown in diagram 1, as at the lower interest rate of point 2, there is a higher quantity of funds demanded then at point 1. The lower interest rates will

mean borrowers pay less on loans and will nd it easier to borrow, thus more investment and consumption leading to more economic activity and growth. As shown, the RBA has a signicant impact on the interest rates and economic activity in Australia, and is important as it tries to ensure a sustainable money market for the Australian economy.