Week 3 - Money & Interest rates Flashcards
What is the function of money
- A unit of account - in which the price of all goods can be specified. i.e. a number.
- A store of value - stores a specific value, however a value is only a good store when inflation is low & stable.
- Acceptable in exchange - it can be used to buy things, something everyone will accept.
What is meant by the term “money multiplier process”
The process banks use to make money. They reinvest someone’s money, but providing a loan to someone else and charging interest on the loan. The interest is what multiples the money.
What is the Reserve ratio?
The percentage of a deposit that banks are required to keep as cash.
However Australia has no set reserve ratio.
What is an Open Market Operation (OMO)?
Buying and selling government bonds
When government bonds are bought back then they are increasing the money supply.
When government bonds are sold they are reducing the money supply.
What is the Target Cash rate (TCR)?
It is when the RBA fixes the short term interest rate.
What are the effects of changing the TCR (target cash rate)?
Higher interest rate = tight policy (contractionary monetary policy). They are trying to slow down the economy.
Lower interest rates = loose policy (expansionary monetary policy). They are trying to expand the economy.
How do interest rates affect savers and borrowers?
Saving or deposit money - The interest rate relates to how much you receive on top of the initial investment. But the term of your deposit will also effect this, longer term investments generally receive a higher rate of interest.
Borrowing money - the interest rate relates to how much on top of the original loan you will have to repay.
How does the flow of money affect the economy?
The quicker the money goes around the better the economy. The slower the money goes around leads to contraction (which could lead to recession).
How do interest rate affect the economy?
Interest rates affect all elements of aggregated expenditure (AE = C + I + G + NX (export - imports).
How do interest rates affect C (consumption)?
High interest rates encourages households to save, to differ expenditure. There is more difficulty on the return from assets (i.e. shares and property).
How do interest rates affect I (Business investment)?
High interest rates discourage firms from new investment in physical capital (i.e. plant, equipment, property). Firms must weigh up the profit generated from the new investment verses putting the same amount as cash in the bank.
How do interest rates affect G (government spending)?
High interest rates increase the interest the government is required to pay back government bonds and banks.
Therefore more public revenue is taken up in interest payments than public spending.
How do interest rates affect NX (exports - imports)?
High interest rates attract foreign money and this causes and increase in the demand for the dollar, which leads to a higher value (appreciation of the dollar).
This negatively impacts exporters because foreign buyers need to pay more of there own currency to get the same product.
Describe the “cut off period” as a way of making an investment decision?
It calculates when all the cost will be recovered by a cut off period.
Describe the “pay off period” as a way of making an investment decision?
Investments are ranked by how long they take to return their cost.
