Extended Response – Economics:
TOPIC: Interest Rates and The RBA
Question: Analyze the factors that influence the level of interest rates and the role of the Reserve Bank of Australia in determining the cash rate:
In economics there are numerous amounts of factors that influence the levels of interest rates in the economy. Overall there are six major factors that influence the levels of the rates; these include the state of the economy, inflation, the Reserve Bank of Australia (RBA) movements, stock market conditions, international borrowings and fiscal deficit and government borrowings.
The first influence is the state of the economy. In a growing economy, people have secures sources of income, and hence have higher confidence and tendencies to borrow money and purchase goods and services. For example, people purchase a car, or house, therefore this increases the demand for funds in an economy. This would therefore increase interest rates, vice versa in a recession economic condition; the interest rates tend to decrease.
The second influence is the rate of inflation in the economy. The lenders prefer lending at interest rates that are higher than the rate of inflation; otherwise they will post a negative growth. Therefore, a rise in the rate of inflation will set off a higher interest rate policy. Once again, vice versa if the rate of inflation decreases, the interest rates will weaken.
The movements of the Reserve Bank of Australia also play a crucial role in determining the level of interest rates, as the RBA is the key player in the economy. The RBA is in charge of determining how an economy is running, and what is the best rate for market equilibrium. For example, in a recession the economy is slowing. In order to stimulate growth the Reserve Bank will lower rates. The purpose is if money is cheaper, more businesses will borrow and expand. Vice versa in a boom, the RBA will increase interest rates to avoid inflation.
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