1. Explain how open market operation determine the cash rate Open market operations (OMO) involve the purchasing and selling of government bonds in the short term money market (STMM). This affects the cash rate by changing the amount of currency available in the STMM, and as the cash rate is in reality the interest rate in the STMM, by influencing the amount of currency, through the factors of supply and demand the cash rate is then changed. This can be seen in the situation where the RBA purchases many government bonds in the OMO, thus releasing a large supply of currency into the market. Due to excess supply, demand for currency falls and there is a corresponding decrease in the interest rates in the STMM.
Therefore two objectives have been met. However, the diagram also shows a conflict. With higher AD there is also demand pull inflation.The extent of any economic growth depends on the elasticity of the AS curve. If there is a small output gap and a more inelastic AS curve then the impact on economic growth will be smaller but there will be more inflation. This is unlikely to be the case in the UK at the moment as low interest rates and a large budget deficit has not cause significant inflation.
Discuss the effectiveness of the monetary policy in increasing AD (25 Marks) The monetary policy involves changes in the base rate of interest to influence the growth of aggregate demand, the money supply and price inflation. Monetary policy works by changing the rate of growth of demand for money. Changes in short term interest rates affect the spending and savings behaviour of households and businesses and therefore feed through the circular flow of income and spending. Monetary policy influences the decisions that we make about how much we save, borrow and spend. There are several ways in which changes in interest rates influence aggregate demand, one of the main changes are through the housing market & house prices.
If anything affects these factors will result in affecting the demand. For example, if inflation is getting too high, interest rates will be increased to stabilize the economic growth in the economy. This is the result of having the economy already close to full capacity which means that a further increase in AD will mainly cause inflation. Demand side policies include monetary policy and Fiscal policy. Monetary policy are actions of central bank, currency board or other regulatory committee that determines the size and rate of growth of the money supply, which in turn affects interest rates.
A bank can normally earn a higher interest rate on loans than on securities, roughly 6%-8%. Loans, however, come with a risk. If the bank makes bad loans to consumers or businesses, the bank will take a hit if those loans are not repaid. Since we have
First, manage rather than own hotel assets. Second, invest in projects that increase shareholder value. Third, optimize the use of debt in the capital structure. Fourth, repurchase undervalued shares. The company regularly calculated “warranted equity value” for its common shares and repurchased its stock whenever the market price fell substantially below that value.
The opposite occurs for a balance of payments surplus. However, the extent to which this occurs depends on the price elasticity of demand for exports and imports on the Marshall Lerner Condition. This condition states that devaluation (a fall in the value of the currency) will lead to an improvement on the current balance will be seen if the combined elasticities of demand for exports and imports are greater than 1. The size of any J-curve affect in the short run will also affect this extent. The J-curve effect is a short term
At last, achieve aggregate demand and aggregate supply to be an ideal balance. Monetary policy is divided into two types: expansionary and tightening. Aggressive monetary policy is to stimulate aggregate demand by increasing the speed of the money supply growth. In this policy, it is easier to obtain the credit, and the interest rates will reduce. Therefore, when the aggregate demand compared with the economic production capacity is quite low, expansionary monetary policy should be taken into use appropriately.
This is an effect of a lower opportunity cost as the overall cost associated with borrowing has decreased and the marginal benefit of saving has increased, meaning consumers will receive more of a benefit if they purchase goods on credit based agreements opposed to saving, leading to an increase in the amount of credit transactions. This leads to consumer expenditure increasing significantly, meaning more goods are being consumed. Therefore, as consumer expenditure is a component of the aggregate demand formulae an increase in consumption would thereby lead to an increase in aggregate demand. However that said, an increase in consumption largely depends on the consumers’ marginal propensity to consume (MPC) and the overall confidence of consumers. Therefore, if MPC and consumer confidence is at a low, consumers will spend less and save more therefore resulting in a decrease in total consumption levels.
The money of the fund is not restricted to investment in only one security but it can be invested in different securities. There is an old saying: Don’t put all your eggs in one basket. This is done to reduce the risk that would rise if the all the fund money was invested in one security. If one invest most of savings in one security due to tremendous gains in that security then he/she is exposed to any risk that faces that investment. A risk of price fall is always there, but losses on some investment with the help of diversification is off set by the gains on others.