ECON1002 Introductory Macroeconomics Week 6

Flashcards about the Reserve Bank, monetary policy, and the economy

Role of Banks

Banks stand between savers and investors facilitating financial intermediation.

Coupon Rate

Rate at time bond issued (not to be confused with the prevailing interest rate).

Coupon Payment (if annual)

Principal x Coupon Rate

Bond Pricing Principle

Bond prices and interest rates are inversely related.

Dividend

A regular payment received by stockholders for each share that they own.

Capital Gains

Shareholders also receive returns in the form of capital gains when the price of their stock increases in the stock market.

Medium of Exchange

An asset used in purchasing goods and services.

Unit of Account

Measuring value.

Currency

Currency; notes & coins.

M1

Currency + current bank deposits.

M3

M1 + deposits of private non-banks.

Bank Reserves

Banks hold a fraction of their deposits as reserves to meet the demand of withdrawals

Desired Reserve-Deposit Ratio

Reserves/Deposits

Money Multiplier

1/(RD ratio)

Money Supply and Prices (Long-Run)

A rapidly growing supply of money leads to quickly rising prices, i.e., inflation.

Quantity Theory of Money

MV = PY, nominal value of expenditure equals money stock times velocity of circulation

Velocity (V)

PY/M

RBA Responsibilities

Maintaining stability of currency and oversight/regulation of financial markets.

Monetary Policy

Conducted by the RBA directly targeting interest rates.

Exchange Settlement Accounts (ESA)

Banks hold reserves in exchange settlement accounts with the RBA

Open Market Operations

RBA purchases bonds to lower cash rate or sells bonds to increase cash rate

RBA's Covid-19 Response

Substantial easing of the monetary policy with cash rate at 0.25 basis points, forward guidance, and quantitative easing (QE).

Forward Guidance (COVID)

Cash rate to be at 0.25 basis points for at least 3 years during COVID

Corridor System around Cash Rate

The reserves held in the ESA earn an interest rate which is 25 basis points below the cash rate and if the bank has to borrow from the RBA on this overnight market, it has to pay 25 basis points higher than the cash rate.

Transmission of Monetary Policy

Cash Rate -> Interest Rates -> Economic Activity -> Inflation

Demand for 90-day Bills

The public buy (demand) 90-day bills as a way of lending money to firms.

Supply for 90-day Bills

Firms sell (supply) 90-day bills as a way of borrowing money from the public

Real Interest Rate

Nominal interest rate minus inflation rate

Base Money

Currency in circulation + deposits banks have with RBA in exchange accounts

Policy reaction Function

Policy reaction function is a simple mathematical representation of how the Reserve Bank adjusts interest rates in light of the state of the economy.