Monetary Policy Flash Cards

Flashcards by murphyb, updated more than 1 year ago
Created by murphyb about 4 years ago


ACT Year 12 Certificate Economics (Monetary Policy) Flashcards on Monetary Policy Flash Cards, created by murphyb on 03/31/2016.

Resource summary

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.
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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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