Cash Rate Decision Essay

1816 words - 8 pages

Central banks are the main determinant of a nation’s economic growth, playing a significant role in the sound function and stability of the financial system. The Reserve Bank of Australia (RBA) is a prime example of a central bank, responsible for the supply of Australian currency notes, the effectiveness of the payments system, developing and implementing the monetary policy and hence the overall solidity of the financial system in Australia. The Reserve’s principal task is to administer The Monetary Policy, which focuses on the management of the official cash rate, also known as the interest rate on overnight loans in the money market. This cash rate is crucial to the economy as it influences many factors such as the behavior of borrowers and lenders, economic activity and ultimately, the rate of inflation (Reserve Bank Of Australia, 2001–2014). On the first Tuesday of every month except for January, the Reserve Bank Board comes together to discuss in depth the current progress of economies and financial markets both in Australia and internationally. A decision on the official cash rate is then made, taking into account the three main objectives of The Monetary Policy, which is to ‘maintain a price stability, full employment, and the prosperity and welfare of the Australian people’ (Reserve Bank Of Australia, 2001–2014). For the month of May, 2014 it is forecasted that the cash rate be sustained at a current level of 2.5 per cent, as in the RBA’s April overview it openly states that “based on the outlook for inflation and activity as it currently stands, the Board’s view is that a period of stability in the policy rate is likely” (Reserve Bank of Australia, 2014). This decision is based on the growth or decline of many factors, such as inflation, investment opportunities (housing) and the movement of international relations.

The rate of which the prices good and services rise and hence purchasing power starts to deteriorate at is known as inflation. Usually assumed as a bad influence on the economy, inflation is actually a natural byproduct of economic growth (Roos, 2008). This can be explained through the “demand-pull” theory, where it can be seen that when more money is being spent on goods than usual, a shortage of supply starts to arise and accordingly cannot meet the rising demand. Prices then start to increase when demand is higher than supply, resulting in inflation. When money is spent more than usual it is often because ‘interest rates are low, and as a result more borrowing power is put into the hands of consumers’ (Roos, 2008). This is why deciding on the interest rate plays a major role in controlling inflation and as a result, the RBA has a principal medium term objective to choose a cash rate that keeps inflation within a target of two to three percent. This makes inflation an important domestic factor in deciding upon a cash rate as in general ‘a rise in the rate of inflation signals a higher interest rate regime, and on the...

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