M, I and tMS and Settlement Cash Flashcards
What is the OCR?
the interest rate that applies to settlement cash accounts held by trading banks at the RB
interest rates in simple terms
An interest rate is either the cost of borrowing money or the reward for saving it.
What happens if Bank A has $10 remaining after it has settles its obligations with bank B?
They can earn interest on the $10 left in their settlement cash account. This interest rate is the OCR
What happens if Bank A doesn’t have enough money in its settlement cash account to pay Bank B?
They hav to borrow from the reserve bank (and then pay interest which would be the OCR and a bit more) or they could go to bank B and owe the remaining and pay it later (with interest)
If the OCR increases, How does this affect banks?
If the OCR increases, this makes it more attractive to have funds in the settlement cash account. This means there is more money in the reserve and therefore an increased RR. There is therefore less credit creation.
It also means that banks have to pay higher interest on borrowing from the RB which also encourages holding money in the SCA. Ultimately if the OCR increases, interest rates will increase
How would the RB respond to inflation?
- they increase OCR
- band tend to hold more reserves in settlement cash account
- higher reserve ratios leads to lower money multiplier
- credit creation process is less
- interest rates rise
- reducing household credit consumption (C), credit funded investment spending of firms (I) and with associated pressure on exchange rates squeezing net exports (NX)
- slowing economic activity
What are the three main mechanisms for influencing the money supply?
- open market operations
- reserve ratio requirements
- discount rates
Describe the tension between banks holding cash and not holding cash when there is a higher OCR
A higher OCR induces banks to hold less settlement cash/reserves. A higher OCR also leads to higher market interest rate. But the banks are running a business so they make profit from their lending - they charge interest rates to borrowers and they pay interest rates to their depositors so if the interest rate is up, at the same time, the banks want to lend more if they can charge a higher interest rate to their borrowers so there is a tension:
higher OCR discourages lending but higher OCR means higher interest rate which encourages lending
There is a positive/negative relationship between market interest rate and the supply of money
positive
If the interest rate (not the OCR) increases, banks will supply additional funds by running down their
reserves
If the interest rate decreases, banks will increase their
reserves
An increase in the OCR will induce banks to hold settlement cash/reserves o reduce the
money supply
Quantity of money in the economy determines the
price level
growth in the quantity of money is the primary causes of
inflation
Temporary bursts of inflation may be caused by a
shock
