Financial Economics Research Papers

This assignment presents a collection of research papers spanning diverse areas within financial economics. Papers delve into topics such as the impact of one-time transfers on microenterprises, the relationship between banks' funding costs and lending rates, the effectiveness of fiscal policy at zero interest rates, and the determinants of non-performing loans. The collection also includes analyses of monetary transmission mechanisms, inflation and output volatility preferences, and the role of foreign exchange reserves in a central bank's balance sheet.

Principles of Economics 1
Running Head “Principles of Economics”
Principles of Economics

Principles of Economics 2
Table of Contents
Introduction.................................................................................................................................................2
Question 1...................................................................................................................................................3
Question 2...................................................................................................................................................6
Question 3...................................................................................................................................................8
Question 4.................................................................................................................................................10
Question 5.................................................................................................................................................13
Conclusion.................................................................................................................................................16
References.................................................................................................................................................17

Principles of Economics 3
Introduction
This report will provide information about the objectives of the monetary policy and the
functions of the reserve bank of Australia. Along with this, the factors that RBA consider when
taking decision about the cash rate will be discussed in this report. The reason behind the
decision about the unchanged cash rate of RBA will be discussed in this report. In addition to
this, what will be the affect on inflation of increase in cash rate and the affect of decrease in cash
rate on economy will also be discussed in this report. This report will also provide information
about the affect of increase in decrease of cash rate on GDP, Inflation, Housing market,
Consumption demand and business investment. Along with this, this report will also provide
information about the view of student about the unchanged rate of RBA.

Principles of Economics 4
Question 1
Objectives of Monetary Policy:
Monetary policy is a process by which the supply of money controlled by the monetary authority
of a country. The objective of monetary policy is different in every country and it also differ by
time. Following are the objectives of monetary policy:
Stability of Exchange:
This is the traditional objective of monetary policy. In different countries exchange stability was
the main objective under gold standard. Whenever disequilibrium occur in the balance of
payment of a country, this disequilibrium automatically corrected by the movement (Smets,
2014). To increase the foreign investment, developing countries pursue stable exchange. If the
exchange rate is stable, than it will be very beneficial for the international trade.
Price Stability:
This is the most important objective of monetary policy. Monetary policy helps to avoid the price
inflation and deflation and this is leads the price stability. Price stability helps to enhance the
confidence of public because it eliminates the price fluctuation like; inflation and deflation.
Monetary policy ensures that all the income and wealth is distributed equally or not. It promotes
imports and discourages the export.
Full Employment:
Full employment refers to that economic situation where all eligible people who want job can
find the job at a good wages rate. Full employment is not 100% employment. Monetary policy is
mainly concern credit and currency, so the policy regarding credit and currency can overcome
the problem of trade fluctuation in the economy of a country (Ball, et al., 2014). When the
economy of a country face the unemployment problem than the monetary authority can help the

Principles of Economics 5
economy by making cheap money policy. Monetary policy also helps to maintain the
employment in the economy by formulating various important policies.
Economic Growth:
Increase in the goods and services produced in a country within a time period are called
economic growth. According to Prof. Meier “economic growth is a process of increase in per
capita income of a country after a long time period”. So the monetary policy help in the
economic growth by maintaining the equilibrium between the demand and supply of the money
and it also helps to increase the conditions for savings and investment (Barro, 2013).
Main functions of the reserve bank of Australia:
The central bank of Australia is known as The Reserve Bank of Australia. This bank was
established by the Reserve Bank Act 1959. The RBA works to encourage the smooth and safe
financial system. The most important function of the RBA is to set the monetary policy of
Australia. The functions of the reserve bank of Australia are as follows:
The stability of currency of Australia:
Stable currency means that currency which performs its functions properly such as; means of
exchange, unit of account etc. This is very important for currency stability that the economy of
the country should be strong. The reserve bank of Australia always checks the inflation in the
market and tries to make the currency stable (Deans and Stewart, 2012). To stabilize the
currency it is very important for the reserve bank of Australia to always check the inflation. In
the simple way it can be said that with your money you can by less than what you buy yesterday
so this is inflation. Thus, Reserve Bank of Australia’s function is to stabilize the currency of the
country.
The maintenance of full employment in Australia:

Principles of Economics 6
Full employment means all the eligible people who want to work can get the job at a good wages
rate. This is also a function of reserve bank of Australia. The reserve bank of Australia making
policies and doing various programs to encourage the full employment (Voigt, et al., 2011). The
RBA doing targeted employment programs because there are many low wages workers and
many black and Hispanic workers who are suffering from unemployment and by this program
the various jobs can be created for the unemployed people.
Holds and manages Australia's foreign currency reserves:
Foreign exchange reserve is that reserve assets which country’s central bank hold to foreign
currencies and this reserve helps to pay the liabilities in the same currency in which it borrowed
(Vallence, 2012). The reserve bank of Australia holds and manage the foreign currency reserve
of the country to pay back the foreign liabilities.
Provide banking services to government:
The central bank of Australia is the bank which provide banking facilities to the government of
the country. The RBA helps the government in various ways like the RBA provide loan to the
government and it also helps the government in the evaluation of the growth of the economy and
it also provide suggestions related to money and economy to the government.
Issuer of the notes:
The reserve bank of Australia has the authority to issue the new currency in the country. No
other bank can do this work instead of the reserve bank of Australia (Kenen, 2011).
Bankers bank:
The reserve bank of Australia is known as the bankers’ bank because this is the only bank which
provide loan to the other commercial banks and control the other banks and set the interest rate.

Principles of Economics 7
Question 2
Cash Rate:
Cash rate is the rate of interest which the reserve bank charges on the loans which it provides to the
commercial banks. The cash rate is decided by the reserve bank of Australia in its economy. The cash rate
can be affected by the transaction between the reserve bank and an institution.
Macroeconomic Indicator:
A part of economic data is called economic indicator. The macroeconomic indicators are
periodically released economic statistics which are released by government and private
organizations. This indicator helps to know the economic condition of a country and it helps to
analyze the current and future possibilities of investment (Louzis, et al., 2012). The main
objective of the macroeconomic indicator is to forecast the exchange rate and for this there are
some factors such as; the gross domestic product (GDP), Producer price index (PPI), Consumer
price index (CPI), employment data and interest rate. So these are the macroeconomic indicators
by which the RBA can set the exchange rate. When deciding the cash rate of Australia the RBA
keep some factors in mind. On the first Tuesday of every month except January the a board
meeting conduct by the RBA and in that meeting the board members decide that is there any
need to change the cash rate. From the many past years the reserve bank of Australia working for
the welfare of the economy and also for the welfare of the Australian people. With the help of
the monetary policy the RBA control inflation and promote the stability of currency, maintain
the full employment and promotes the economic and public growth. The RBA make decision
whether to change or keep the official cash rate unchanged on the basis of how much money is
circulating around the country. To decide whether to increase or decrease the cash rate the RBA
take into account the following factors:

Principles of Economics 8
International Economic Condition: While deciding the cash rate the RBA consider the strength
of global economy. It considers the strength of China, USA etc (Sobatka, et al., 2011).
Domestic Economic Condition: To know the domestic economic condition the reserve bank of
Australia look at the employment and unemployment level of the country. Along with this the
RBA look at the currency, inflation figures and the household debts.
The Stability of Financial Markets: The reserve bank of Australia evaluates the performance of
the financial institutions and also evaluates the lending and deposit accounts rate. The RBA also
look at how the financial institutions working in wholesale markets (Schumaker, et al., 2012).
Review of the previous decision: At the final step, the reserve bank of Australia reviews its
previous decisions and evaluates that how their previous decision affected the local banking. The
review of the previous decision helps to know the impact of inflation on their projection and it
also helps to know about the future growth.
The reserve bank of Australia evaluate the above factors and then take decision on the basis of
the factors that the cash rate should be increase or decrease or should remain the same.
Question 3
On 1st August 2017, in the meeting of board the reserve bank of Australia decided to keep the
cash rate unchanged at 1.5%. The main reason why the RBA did not raise the cash rate was the
past weak inflation reading. The experts expected that the inflation will rise 0.4% but the
inflation rise only 0.2%. The governor of the RBA, Dr. Philip Lowe said that the global economy
condition will improve in the future. The reserve bank of Australia said that the low level of
interest will beneficial for the Australian economy. According to the statement of the RBA, in
the meeting of board, the members take decision to remain unchanged the cash rate because it
will help in the sustainable growth in the economy and will also help to achieve the inflation rate.

Principles of Economics 9
The value of Australian dollar was raised above US80¢, and it was raised second time in two
weeks (Moessner, et al., 2017). The governor of the RBA said that the forecast for the Australian
economy was unchanged. According to Dr. Philip Lowe the reason behind the unchanged cash
rate is that the lower cash rate will encourage the household borrowing and will decrease the risk
that economy is facing. To support this decision the RBA said that the decision which they made
is just to support the borrowing of the household. The RBA said that the price growth in Sydney
was slow and the interest rate was high that attracting the investors. The reason behind the
unchanged rate was the increase in the inflation rate in the over few years. Inflation is that
condition where the prices of the goods and services increase and the inflation is measured as
annual percentage change. With the decision of unchanged cash rate the RBA also stated that the
inflation will grow over 3 percent over the next couple of years and the inflation will increase the
economy by A$1.7 trillion. The governor of the RBA said that the export of the country is rising
continuously and investment in the non mining is also increasing. The consumption is same but
the earning of the households remained low (Otto and Voss, 2011). The RBA said that if they
dope the rates than it will increase the housing market and if they increase the rates than it will
decrease the consumption and the investment and also affect the Australian dollar. The Governor
of the RBA also stated that the condition is the housing market is not the same around the
country. In some markets the prices are strong and in other markets prices are declined, so
deciding the rate is not so easy. The RBA expected that the cash rate will increase in the mid of
2018 by 0.25% and the cash rate will be 1.75%. The cash rate of the RBA can be understood
from the following graph:

Principles of Economics 10
From the above graph it is shown that the cash rate of RBA is remain unchanged at 1.5%. The
changed in the interest rates in Australia in long term can be understood from the following
graph:
This graph clearly showing that the cash rate of RBA is changing from last couple of years but in
the 2017 it is unchanged and same as the rate of 2016.
Question 4
Money Market Equilibrium:
The money market is a model of economic which describe the demand and supply in the country.
The money market equilibrium is that point where the quantity of money demanded is equal to
the quantity of money supply (Vazirani and Yannakakis, 2011). The money market equilibrium
can be understood from the following graph:

Principles of Economics 11
Monetary transmission mechanism:
Monetary transmission mechanism is a process by which the decisions related to monetary
policy passed on to the businesses and households through the financial markets. The monetary
decisions influence the aggregate demand, amount of money and interest rates (Lewis and Poilly,
2012).
Inflation is that condition where the prices of the goods and services increase. In broad sense it
can be said that the inflation is increase in the cost of living as a result of increase in the price of
goods and services. If the cash rate of the country will low than more people can borrow money
from the banks and this increase the spending of people and it increase the inflation. By
increasing the cash rate from 1.5% to 2% the borrowing can be decreased and people will spend
less money, the savings will higher and the economy slows and inflation decrease (Barr and
Diamond, 2011). When the people of a country spend more money and the inflation increases in
a country than the reserve bank increase the cash rate so the people spend less money and to
maintain the inflation. The changes in the GDP of Australia because of the increased in cash rate
in past few years can be understood from the following graph:

Principles of Economics 12
The above graph clearly describe that the GDP of Australia faced fluctuation in last few years
and the GDP is affected by the cash rate that the reserve bank of Australia set for the economy.
The reserve bank of Australia increase the cash rate and the public borrow less money and spend
less than the GDP of the country decrease.
Apposite to this when reserve bank decreases the cash rate it means the interest rate will also
decrease. Low interest rate increases the borrowing. If the reserve bank decrease the cash rate
from 1.5% to 1% this clearly increases the spending and investment of the people of the country.
The decrease in the cash rate directly increases the aggregate demand and economic growth. If
the banks will provide loans in cheaper interest rate than most of the people want to borrow the
money and many businessman also borrow the money and invest that money into businesses. If
the interest will low than it will provide low interest on saving also so this decreases the savings
and increases the spending. Reserve bank decrease the cash rate when the public decrease the
spending and borrowing and increase their savings. Low cash rate increases the inflation. The
increase and decrease in the inflation of Australia can be understood from the following graph:

Principles of Economics 13
From the above graph it can be understand that in 2014 the cash rate was higher that’s why the
inflation was higher but in 2017 the cash rate of Australia is 1.5% and this is low that’s why the
inflation in Jan. 2017 is lower than the inflation of 2014.
Question 5
Effect of increasing and decreasing the Cash Rate:
Increasing the cash rate means increasing the interest rate of the commercial banks. The public
will earn more interest on savings and the public will also pay more interest on the borrowing.
On the other hand decrease in the cash rate means the public can borrow more money from the
banks on cheap interest rate and businesses can also borrow money to investment. The effect of
increase or decrease cash rate can be understood from the following discussion:
Effect on Consumption Demand:
If the cash rate will increase than the consumers cannot borrow money from the banks and also
they want to save the money to earn higher interest so they will not spend their money to buy
goods and services. Thus, the consumption demand will decrease because of the increase in cash
rate. On the other hand if the cash rate will decrease than the consumers can borrow more money
and will decrease their savings and will spend more money (Diamond and Rajan, 2012). This

Principles of Economics 14
will increase the consumption demand. For example; if the RBA increase the cash rate from
1.5% to 2% than the consumption demand in Australia will decrease and if the cash rate decrease
from 1.5% to 1% than the consumption demand will increase.
Effect on Business Investment:
If the cash rate will increase than it will negatively affect the business investment. For the
investment in the business an investor will borrow money from the banks and if the bank will
provide loan on higher interest rate than no one wanted to borrow money for the investment and
indirectly the investment will decrease (De Mel, et al., 2012). If the cash rate decrease than the
business investment will increase. For example; if the RBA increase the rate from 1% to 1.5%
than the investors will not borrow money and opposite to this if the RBA decrease the cash rate
from 1% to 0.75% than the business investment will increase.
Effect on GDP:
The increase cash rate also affects the GDP of a country. Higher cash rate means the public
cannot borrow money and will increase the savings and will spend less and this negatively
affects the GDP. On the other hand if the cash rate decrease than the public will spend more
money and decrease their savings and this increase the GDP.. For example; if the RBA increase
the cash rate from 1.5% to 2 % than the public will not borrow the money and will increase their
savings. And if the cash rate decrease from 1.5% to 1% than the public will spend more money
and GDP will grow.
Effect on Inflation:
Inflation is that situation where price of goods and services increases. If the cash rate will
increase than the inflation will also increase and if the cash rate will decrease than the inflation
will also decrease (Eggertsson,2011). For example; if RBA increases the cash rate from 1% to

Principles of Economics 15
1.5% than the inflation will increase and opposite to this if RBA decrease the cash rate from 1%
to 0.5% than the inflation will also decrease.
Effect on Housing Market:
If the reserve bank increases the cash rate than the public cannot borrow money to buy a house
and opposite to this id the cash rate decrease than the public can borrow money and than more
people will buy house. For example; of RBA increases the rate from 2% to 2.5% than housing
market will suffer from loss and if the cash rate decrease from 2% to 1% than more people will
buy houses and housing market will earn profit.
The historical low interest rate of 1.50% is not sustainable to achieve long run economic growth
because changes in the cash rate required after some time. If the cash rate will remain same than
the people who are not willing to invest money or not borrowing the money because of the
higher interest rate will never borrow the money and will not increase their standard of living.
The cash rate is depends on the inflation level so if the inflation will change in future than the
cash rate will be changed.

Principles of Economics 16
Conclusion
From the above discussion it can be concluded that there are some objectives of monetary policy
such as; stability of exchange, price stability, full employment etc. It can be also concluded that
Maintenance of full employment , managing foreign currency, issuing the notes etc. are the
functions of RBA. It can be also concluded that when setting the cash rate the RBA consider
some factors such as; international economic condition, domestic economic condition and the
stability of financial market. It can be also concluded that the RBA decided to keep the rate
unchanged for the growth of the economy. Along with this it can be concluded that if the interest
rate will increase from 1.5% to 2% than the inflation will also increase and if the cash rate
decrease from 1.5% to 1% than the public can borrow more money and spend more. In addition
to this, it can be conclude that there are some positive and negative effect of increase and
decrease of cash rate on GDP, inflation, business environment, housing market and consumption
demand. Along with this it can be concluded that with constant cash rte the RBA cannot achieve
the long term growth.

Principles of Economics 17
References
Ball, L., DeLong, B., & Summers, L. (2014). Fiscal policy and full employment. Center on
Budget and Policy Priorities, abril [en línea] http://www. pathtofullemployment. org/wp-
content/uploads/2014/04/delong_summers_ball. pdf.
Barr, N., & Diamond, P. (2011). Improving Sweden’s automatic pension adjustment
mechanism. Center for Retirement Research at Boston College, 11(2).
Barro, R. J. (2013). Health and economic growth. Annals of Economics and Finance, 14(2), 329-
366.
De Mel, S., McKenzie, D., & Woodruff, C. (2012). One-time transfers of cash or capital have
long-lasting effects on microenterprises in Sri Lanka. Science, 335(6071), 962-966.
Deans, C., & Stewart, C. (2012). Banks’ funding costs and lending rates. Reserve Bank of
Australia Bulletin, 2012, 37-43.
Diamond, D. W., & Rajan, R. G. (2012). Illiquid banks, financial stability, and interest rate
policy. Journal of Political Economy, 120(3), 552-591.
Eggertsson, G. B. (2011). What fiscal policy is effective at zero interest rates?. NBER
Macroeconomics Annual, 25(1), 59-112.
Kenen, P. B. (2011). Currency internationalization: an overview. BIS Papers, 61, 9-18.
Lewis, V., & Poilly, C. (2012). Firm entry, markups and the monetary transmission
mechanism. Journal of Monetary Economics, 59(7), 670-685.
Louzis, D. P., Vouldis, A. T., & Metaxas, V. L. (2012). Macroeconomic and bank-specific
determinants of non-performing loans in Greece: A comparative study of mortgage, business and
consumer loan portfolios. Journal of Banking & Finance, 36(4), 1012-1027.

Principles of Economics 18
Moessner, R., Jansen, D. J., & de Haan, J. (2017). Communication about future policy rates in
theory and practice: A survey. Journal of Economic Surveys, 31(3), 678-711.
Otto, G., & Voss, G. (2011). What do the RBA’s Forecasts Imply about its Preferences over
Inflation and Output Volatility?. Economic Record, 87(279), 509-524.
Schumaker, R. P., Zhang, Y., Huang, C. N., & Chen, H. (2012). Evaluating sentiment in
financial news articles. Decision Support Systems, 53(3), 458-464.
Smets, F. (2014). Financial stability and monetary policy: How closely
interlinked?. International Journal of Central Banking, 10(2), 263-300.
Sobotka, T., Skirbekk, V., & Philipov, D. (2011). Economic recession and fertility in the
developed world. Population and development review, 37(2), 267-306.
Vallence, C. (2012). Foreign Exchange Reserves and the Reserve Bank’s Balance Sheet. RBA
Bulletin, December, 57-63.
Vazirani, V. V., & Yannakakis, M. (2011). Market equilibrium under separable, piecewise-
linear, concave utilities. Journal of the ACM (JACM), 58(3), 10.
Voigt, C., Laing, J., Wray, M., Brown, G., Howat, G., Weiler, B., & Trembath, R. (2011). Health
tourism in Australia: Supply, demand and opportunities.