Interest Rates Recap

Poll

On a scale of 1-5, (with 1 being not at all confident, and 5 being very confident)

How confident would you be if you were asked to write an extended response on the money market today?

• 1

• 2

• 3

• 4

• 5

​Interest Rates Recap

Success Criteria

To consolidate ​knowledge of the money market.

Learning Intention

Learning Intention and Success Criteria

Some text here about the topic of discussion

• I can recall the different sectors of the money market

• ​I can explain why funds are lent and borrowed

• ​

Learning Intention and Success Criteria

LI: To Consolidate knowledge of the money market

SC:

Recall the different sectors of the money market

Explain why funds are lent and borrowed ​

​Describe the role that the RBA plays in determining the cash rate

​Evaluate contemporary economic conditions with theoretical concepts

Open Ended

What are some reasons why individuals borrow money?

Individual Demand for Funds

Personal Reasons​

The most common reason for individuals to borrow funds are personal reasons. Mortgages are the most common long-term borrowing form, while short-term loans may be for a number of reasons.

​The Borrowing and Lending of Funds

Multiple Choice

Holding a certain quantity of funds to complete day-to-day business and administration

• Transactions Motive

• Speculative Motive

• Precautionary Motive

Multiple Choice

When unpredictable circumstances arise that require liquidity of funds

• Transactions Motive

• Speculative Motive

• Precautionary Motive

Multiple Choice

The holding of liquid funds to avoid capital losses

• Speculative Motive

• Transactions Motive

• Precautionary Motive

Factors affecting the Demand for Funds

The complexity of the financial system

In simple financial systems, whereby the transformation of financial assets into liquid funds, is a relatively slow process, individuals will seek to hold larger quantities of liquid assets.

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Conversely, in a more complex system, whereby liquid funds can be attained with greater ease, individuals will tend to hold less liquid funds. ​

Aussies boosted ‘rainy day’ funds by almost 50% during COVID in expectation of economic shocks

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Open Ended

Using the theoretical knowledge we have recapped, explain the economic concepts that are presented within this article. (3-5 sentences)

Individuals who place deposits in financial institutions are, in effect, lending their money, for the purpose of receiving a return. Individuals have a range of options when it comes to lending, with each option presenting a varying level of risk.

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​Lenders: The Supply of Funds

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Open Ended

What are the options that individuals have when it comes to lending?

Lenders: The Supply of Funds

Businesses

Businesses may also seek to deposit their funds into a financial institution, in the same way as individuals, seeking a return. This usually occurs where depositing funds yields a greater return that potential expansion of the business.

Lenders: The Supply of Funds

Governments

Historically, Governments are seen as borrowers of funds. However during budgetary surpluses, Governments may loan money through the financial sector.

Lenders: The Supply of Funds

The International Sector

Domestic borrowers ​may seek funds from overseas financial institutions. International financial institutions will seek the greatest return, and as such will choose to lend their funds in countries where interest rates are relatively higher.

​When it comes to why funds are lent out:

​The Four Characteristics of Money

How Money is Measured in Australia:

Multiple Choice

Regarding the money supply (M3), what percentage is made up of currency in circulation?

• 10%

• 50%

• 5%

• 95%

Draw

Fill in the interest rate determination diagram below:

Interest Rate Determination

The rate of interest charged by financial institutions on loans is known as the lending rate.

Lending Rate

When financial institutions accept savings deposits, the rate of interest being charged is known as the lending rate.

Borrowing Rate

-Dixon Textbook, paraphrased​

Financial Institutions charge a lending rate that exceeds their borrowing rate. This allows financial institutions to make a profit, and is known as the interest rate differential.

Factors that influence interest rates

Split into pairs/threes, forming 7 groups.

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Each group will be given a factor that influences interest rates.

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Using the Dixon textbook (pgs 200-201), and your own research, explain your factor to the class.

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Open Ended

This section is for one member of your pair/three to submit your response to the previous activity.

Multiple Choice

Which interest rate does the RBA directly manage?

• Cash Rate

• Variable Rate

• Domestic Rate

​- The RBA

"Exchange Settlement Accounts (ESAs) are the means by which providers of payments services settle obligations that have accrued in the clearing process"

But what does this mean?

The RBA and the Cash Rate

Exchange Settlement Accounts

Banks must hold a certain level of funds with the RBA in exchange settlement accounts. These accounts are used to settle payments with other banks and the Reserve Bank.

The RBA and the Cash Rate

The Overnight Money Market

This is where banks will purchase or sell funds to top up exchange settlement accounts.

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This is also the market within which the cash rate is determined. The RBA intervenes heavily within this market to achieve a cash rate at their target.

The Policy Rate Corridor

The Policy Rate Corridor

How does it work?

Just like regular banks, the RBA establishes a lending rate and a borrowing rate for exchange settlement accounts. These rates are designed around an established cash rate target, and makes up the policy rate corridor.

The Policy Rate Corridor

The Borrowing Rate

The RBA establishes its borrowing rate 0.1% below the cash rate target. This is the rate at which commercial banks can deposit additional exchange settlement account funds.

​

​

The Policy Rate Corridor

The Borrowing Rate

This gives banks with surplus ESA funds two options:

1. Deposit additional funds at the lower borrowing rate.

2. Lend these additional funds on the overnight money market, at the cash rate. ​

​

​

The Policy Rate Corridor

The Borrowing Rate

If the cash rate is below the RBA borrowing rate, banks will just choose to deposit their additional funds with the RBA, as this yields the larger financial return.

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Banks who require ESA funds will offer returns higher than the borrowing rate to banks, thus raising the cash rate above the floor that the borrowing rate creates. ​

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Multiple Choice

What is the current RBA borrowing rate?

• 1.85%

• 1.65%

• 1.60%

• 1.75%

The Policy Rate Corridor

The Lending Rate

The RBA establishes its lending rate at 0.25% above the cash rate target. This is the rate at which banks can loan exchange settlement account funds from the RBA.

​

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The Policy Rate Corridor

The Lending Rate

This gives banks with an ESA fund deficit two options:

1. Borrow from the RBA at a higher rate.

2. Borrow from the overnight money market, at the cash rate.

​

The Policy Rate Corridor

The Lending Rate

If the cash rate is above the RBA lending rate, banks will simply choose to borrow from the RBA, as this presents a lower cost relative to borrowing from the overnight money market.

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​Banks with surplus ESA funds will ​offer interest rates below the RBA lending rate, thus lowering the cash rate below the ceiling that the lending rate creates.

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The Policy Rate Corridor

The policy rate corridor is a self-correcting system whereby any alteration to the cash rate target by the RBA is met by an immediate change in the borrowing and lending rates also.

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The policy rate corridor is the main tool used by the RBA to manipulate the cash rate. ​

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The RBA and the Cash Rate

Open Market Operations

The Policy Rate Corridor provides a broad range that the cash rate will sit in on a daily basis.

​

Open market operations ensure that the cash rate (which is the point at which the demand for ESA funds intersects with supply), doesn't just bounce around within the corridor. ​

Where demand is less than the cash rate target, the cash rate will trend higher than the target. The RBA will sell securities to commercial banks and withdraw the funds from the banks ESA's.

Demand < Supply

Where demand is greater than the cash rate target, the cash rate will trend lower than the target. The RBA will purchase securities from commercial banks and deposit the funds into these banks ESA's.

Demand > Supply

Open Market Operations

Draw

Given the cash rate target is 1.85%, how would the RBA respond to a cash rate of 1.91%? Draw a diagram below representing this response.

Open Market Operations

From the Dixon Textbook (pg. 204):

OMO may involve either outright purchases or sales of securities, such as second-hand Commonwealth government bonds, or repurchase agreements (also called repos), where the “seller” of a bond or security effectively agrees to buy the bond or security back from the “buyer” at a later date. In practice, the RBA prefers using repos to conduct OMO because they are much more flexible instruments and can be used to manage ES supply much more

precisely than outright transactions.

Open Ended

Discuss in pairs what you can remember about the transmission of monetary policy. Type your response below.

The Transmission of Monetary Policy

Loose Monetary Policy

This is where the RBA reduces the cash rate target. It becomes "cheaper" for banks to purchase ESA funds. This is passed on to consumers and businesses in the form of lower repayment funds. This boosts consumption and investment spending as extra funds are available. This increases economic growth, and drives inflation.

The Transmission of Monetary Policy

Tight Monetary Policy

This is where the RBA increases the cash rate target. It becomes more expensive for banks to purchase ESA funds. This is passed on to consumers and businesses in the form of higher repayment funds. This reduces consumption and investment spending as repayments require a larger financial commitment. This reduces economic growth, and lowers inflation.

- Stephen Koukoulas, Tweet

​8:22AM 08/08/22

"1. If RBA hikes interest rates too much there will be a recession.

2. If RBA doesn't hike rates enough, wealth destroying inflation will persist.

3. If RBA hikes rates by about the right amount, the economy will slow & inflation will return to target. The sole media focus is 1."

Open Ended

Discuss the above Stephen Koukoulas tweet using the economic concepts we have explored in this lesson. (3-5 sentences)

Fixing inflation isn’t hard. Returning to healthy growth isLoading 3rd party ad contentLoading 3rd party ad contentLoading 3rd party ad contentLoading 3rd party ad content

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Open Ended

Given current economic conditions, discuss the effect that an increase to inflation rates will have on the Australian economy? (3-5 sentences)

Poll

On a scale of 1-5, (with 1 being not at all confident, and 5 being very confident)

How confident would you be if you were asked to write an extended response on the money market today, having finished the lesson?

• 1

• 2

• 3

• 4

• 5

Open Ended

Did your response to the poll change from before the lesson? Why?/Why not?

Learning Intention and Success Criteria

LI: To Consolidate knowledge of the money market

SC:

Recall the different sectors of the money market

Explain why funds are lent and borrowed ​

​Describe the role that the RBA plays in determining the cash rate

​Evaluate contemporary economic conditions with theoretical concepts

​Overview - Topics Covered

​Demand for Funds (Borrowers) ​

Supply of Funds (Lenders)​

The Characteristics and Measurement of Money ​

Interest Rate Determination

The RBA and the Cash Rate ​

The Policy Rate Corridor

Open Market Operations

Transmission of Monetary Policy ​

Application to Contemporary Economic Conditions ​

Open Ended

Considering the list above, are there any topics that you are still unsure of, or require more revision of?