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Explain Monetary Policy And How/Why It Is Used To Regulate Australia's Economy.

1167 words - 5 pages

With today's market becoming increasingly deregulated, privatised and capitalist, the government has seen a dramatic loss of economic control in recent years. Monetary Policy is one of the government's strongest influential tools of the modern economy so that if it may promote:·Stability of the Australian currency·Full employment·Economic prosperityIt is the duty of the Reserve Bank of Australia (RBA) to use Monetary Policy to best achieve these goals for the government. The Business cycle is a continual cyclic fluctuation of boom and bust which echoes throughout the economy. Monetary Policy alters the money market, the core of the business cycle, in order reduce the extremities of the cycle and produce slow sustainable economic growth.The RBA is able to alter the money market by influencing interest rates throughout the economy. This is done through a complex system in Domestic Market Operations (DMO). Banks are require to have a certain proportion of their funds held by the RBA in exchange settlement accounts. This is because every day there is a large amount of funds transferred between banks in everyday market operations, at the end of each day these amounts are tallied up and cancelled out. Sometimes banks are left with an overnight deficit and require an overnight loan to cover this.The RBA, however, affects these short-term money markets by changing the cash rate. This is done by either buying or selling second-hand government securities to the FI's it deals with. By buying or selling these government securities the RBA increases or decreases the supply of funds within the short term money market and as demand is constant this will effectively alter the cash rate.This may be clarified in the following 2 scenarios:1.-The RBA sells government securities in the short term money market to FI's-The RBA gains funds from selling these securities and equally the short term money market loses these funds through purchasing securities.-Less money in the money market = Less Supply-Less supply= Increased cash rate2.-The RBA buys government securites in the short term money market from FI's-The RBA loses funds by purchasing these securities and equally the short term money market gains these funds by selling these securities.-More money in the money market = More Supply-More Supply= Lower cash rateAs Financial Institutions are the main source of all loans the cast rate shall echo through onto the economy to enable the RBA to effect the economy as a whole.A tightening of Monetary Policy is an upward pressure on interest rates caused by the RBA reducing the Supply of funds within the short term money market (scenario 1). As interest rates rise the economy will follow trends of reduced consumer spending due to increased cost of mortgages and loans and lower business investment this will domino through the many areas of the economy (unemployment, welfare, etc) and overall lower economic activity.An easing of Monetary Policy is downward...

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