Major Determinants of Interest Rates

Topics: Inflation, Money supply, Monetary policy Pages: 5 (1999 words) Published: May 2, 2013
Major Determinants of Interest Rates
Inflation is a factor that decisively affects the nature or outcome of interest rates. “Inflation is an increase in prices of goods and services over time”(Financial Institutions, Instruments and Markets, 2012). Inflation is the natural byproduct of a robust, growing economy. No inflation, or deflation (the lowering of prices), is actually a much worse economic indicator. Also, in a healthy economy, wages rise at the same rate as prices. A standard explanation for the cause of inflation is "too much money chasing too few goods" This is also called the demand-pull theory. For several possible reasons, more money is being spent than normal. This could be because interest rates are low and people are borrowing more. There's not enough supply to keep up with the rising demand for homes, cars etc. Manufacturers are producing goods at a slower rate than people are demanding goods. When supply is less than demand, prices go up. (How Stuff Works, 2012) Different types of interest rate are linked and influence each others, for example if unemployment rates were relatively high the RBA would lower interest rates so that the functioning of the financial markets remain positive and Australia would continue a healthy economic status. The inflation rate in Australia was recorded at 1.20 percent in the second quarter of 2012. Historically, from 1973 until 2012, Australia Inflation Rate averaged 5.83 Percent reaching an all time high of 17.60 Percent in March of 1975 and a record low of -0.30 Percent in September of 1997. The most well known measures of Inflation are the CPI which measures consumer prices, and the GDP deflator, which measures inflation in the whole of the domestic economy. (Trading Economics, 2012) Inflation target is a tool to guide monetary policy expressed as a preferred range or figure for the rate of increase in prices over a period. In Australia, the inflation target is between 2 and 3 per cent per annum on average over the course of the business cycle. (RBA, 2012)

With all this information given, with the current inflation rate sitting at 1.2 per cent, down from 1.6 per cent the previous quarter and the RBAs target being at around 2-3 per cent, we can determine that the Australian economy is in prime position for our engineering firm to invest as at this point the economy in our eyes looks confident and optimistic to invest as there could be an economic boom. During low inflation the quantity of earnings is high in firms and = therefore the investments in a company also increase. Money Supply

Money Supply is another factor that certainly affects the nature or outcome of interest rates. “Money supply is the entire stock of currency and other liquid instruments in a country's economy as of a particular time” (Investopedia, 2012). The money supply in easier terms is any current cash, coins and balances held in checking and savings accounts that the public hold in Australia. “Economists analyse the money supply and develop policies revolving around it through controlling interest rates” (Investopedia, 2012). Money supply data is collected, recorded and published periodically in Australia after the money supply increases or decreases in the economy. Public and private sector analysis is performed because of the money supply's possible impacts on interest rates, price level, inflation and the business cycle. From 1 July 1998, a new system came into place for the financial regulatory framework in response to the recommendations of the Financial System Inquiry (Wallis Committee). Under these arrangements, the Reserve Bank of Australia has stronger regulatory powers in the payments system in accordance with the Payments Systems (Regulations) Act 1998 (Cwlth) (ABS, 2012). The money supply is important to economists trying to understand how policies will affect interest rates and growth. Monetary policy is the process by which the Reserve Bank of Australia (RBA) manages...
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