Economic Monetary Policy

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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. Alternatively, The RBA may choose to sell government bonds; decreasing the supply of currency and consequently increasing the cash rate. 2. Explain how monetary policy is transmitted into the economy Monetary policy refers to the process by which the RBA controls the supply of money within the Australian economy. It achieves this through a process known as the transmission mechanism, which occurs in a number of distinct stages: - Purchasing and sale of government bonds in the STMM to influence the cash rate - Changes in the cash rate influence other interest rates, particularly short term securities, such as bank bills. In this way, changes in monetary policy are usually translated into the rates that banks charge for lending. - These lending rates then influence the decisions of businesses and household to borrow and spend, as seen in Figure 1, providing a key channel for transmitting monetary policy to the real economy. 3. Explain the possible impacts of loose monetary policy on the value of the exchange rate and on economic growth in Australia The effect of an expansionary monetary policy is to lower the exchange rate, weaken the financial
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