Report on the speech 'Today's Reduction in the Cash Rate' 2022

Running head: ECONOMICS
Report on the speech "Today's Reduction in the Cash Rate"
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Executive summary
The monetary policy of Australia is controlled by the Reserve Bank of Australia. In the recent
times, RBA has reduced the cash rate to 0.75%, which is a historic low to achieve the target
inflation of 2 to 3% in the medium term. This move in the monetary policy is expected to boost
domestic demand production, increase in disposable income and increased level of spending. On
the other hand, fall in the interest rate discourages savings, deposits and investments by lowering
asset values. Investment in securities is expected to rise due to cut in cash rate. This report also
highlights the importance of leverage in the economy and money supply, along with an overview
of the ADIs, and Basel Accords. The discussion is primarily based on two articles, namely,
‘Today’s Reduction in the Cash Rate’, the speech by Philip Lowe, RBA Governor and ‘RBA
joins race to the bottom’, by Greber and Shapiro (2016).

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Table of Contents
1.0 Introduction................................................................................................................................3
2.0 Discussion..................................................................................................................................4
2.1 Role of RBA in implementing monetary policy....................................................................4
2.2 Current economic environment (inflation and interest rates) of Australia and effects of
monetary policies on financial markets including asset values and yields..................................5
2.3 Importance of leverage..........................................................................................................7
2.4 Impact of monetary policy on securities values, individual’s personal savings accounts,
investment in superannuation and/or managed fund investments...............................................8
2.5 Functionalities of Authorised Deposit Institutions (ADIs) and role of Basel accord ii, iii or
iv (proposed) in dealing with capital and liquidity risks in Australia..........................................9
3.0 Conclusion...............................................................................................................................10
References......................................................................................................................................12

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1.0 Introduction
The economy of Australia is controlled by its central bank, that is, Reserve Bank of
Australia (RBA), similar to any other economies of the world. RBA controls the economy
through monetary and fiscal policies that influence the interest rates, inflation rates and all other
economic variables and environment. The country has experienced a positive economic growth
for more than two decades (Cornish 2016). However, the Australian economy has not achieved a
good inflation rate in the recent years, which has been affecting the employment level and
growth of the income. Hence, RBA slashed the cash rate by historic low of 0.75% basis points in
August after 2.5 years to stimulate the economic growth and reach the target inflation rate of
more than 2% (Nguyen and Wang 2019). There are significant implications of lowering the cash
rate in the economy and the RBA targeted to achieve the medium term for a sustainable
economic growth. This report presents an in-depth discussion on the incidence of interest rate cut
by the RBA and its influence on the existing economic environment, that is, interest and inflation
rates, role of RBA in implementing the monetary policies and its effect on security values,
individual’s personal savings accounts, investment in superannuation and/or managed fund
investments. It will also discuss Authorized Deposit Institutions’ (ADI) role in dealing with the
liquidity, credit, operating and interest rate risks in Australia and some other macroeconomic
phenomena in detailed manner on the basis of two articles, firstly, the speech by the RBA
Governor, Dr. Philip Lowe on the cash rate cut, ‘Today’s Reduction in the Cash Rate’, and
secondly, the article, ‘RBA joins race to the bottom’, by Greber and Shapiro (2016).

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2.0 Discussion
2.1 Role of RBA in implementing monetary policy
Monetary policy refers to the macroeconomic procedures involving the activities related
to the money supply in the economy. In other words, monetary policy depicts the actions of the
central bank of an economy to control the money supply and circulation in an economy through
various instruments such as cash, credit, checks and mutual funds in the domestic money market
(Kurov and Stan 2018). The monetary policy is designed with the purpose of achieving
economic growth and reducing inflation by increasing or decreasing liquidity respectively. Thus,
the major objectives of monetary policies in any economy include controlling inflation, reducing
unemployment and promoting moderate interest rates in the long term (Cornish 2016).
In Australia, RBA formulates and implements monetary policy and this policy includes
decisions on the determination of the interest rates on the overnight cash funds, known as the
cash rate (Johnson 2017). This rate affects various other interest rates in various degrees and also
the behavior of the borrowers and lenders in the money market. As highlighted by RBA (2019),
the monetary policy framework is centered on the inflation target and setting the cash rate. Thus,
RBA keeps the cash rate most closer to the target to implement an efficient monetary policy. In
order to do that, RBA conducts money market transactions, such as, the ‘open market operations’
are conducted as auctions. As stated by Osell (2018), the open market operations by the central
bank of an economy are meant to raise or lower the amount of cash money held by the
commercial banks. RBA also helps the banks in managing the cash under the regulatory terms
where the rates of lending and deposit create a bracket of 0.25% points overhead and beneath the
target of cash rate. This bracket helps RBA to keep the cash rate closer to the target. The central
bank also lends cash money to the commercial banks at a rate of interest, which is 0.25% points

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above the target cash rate, and the commercial banks also would not borrow the cash at a higher
rate than the determined interest rate and hence, money market does not exist above this
specified lending rate. Moreover, the commercial banks deposit their cash with RBA at a rate
below the 0.25% points lower than the cash rate target, that the Cash Reserve Ratio (CRR) of
these banks are determined 0.25% points below the cash rate. They do not lend money at any
further lower rate and hence, no market exists below this particular deposit rate (Rba.gov.au
2018).
The regulatory requirement on the central bank in Australia is imposed by the
government and the guidelines are presented in the Banking Regulation Guide. This guide
documents the overview of governance as well as supervision of the banks, which includes the
regulatory bodies, legislation, international standards, liquidity roles, licensing, FDI
requirements, recent market trends on regulations and liquidation regimes (Rba.gov.au 2016).
Although, the financial decisions are made by RBA independent of the political scenario, the
bank is required to establish some other policies that would benefit the economic growth through
the banking sector. Those include regulatory programs such as opportunities for equal
employment, encouragement for diversity inclusion, provisions for health and safety in the
workplace, adequate compensation and rehabilitation facilities, application of the Freedom of
Information Act 1982 (FOI Act), legislative obligations for anti-money laundering/counter-
terrorism financing (AML/CTF) etc. (Atkin and Cheung 2017).
2.2 Current economic environment (inflation and interest rates) of Australia and effects of
monetary policies on financial markets including asset values and yields
The current inflation rate (Consumer Price Index or CPI) in Australia is 1.6% as of June
2019 (Rba.gov.au (b) 2019). The rate of interest depends on the cash rate specified by RBA,

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which was cut down by 75 basis points in total. These 2 factors affect the economic growth of a
nation significantly. Monetary policy is thus devised by the central bank of the country to control
these factors to promote economic growth. It has been observed that the inflation rate has stayed
less than 2% for quite a long time affecting the pace of economic growth, which pushed RBA to
lower the cash rate to a historic low. In June 2019, the economy of Australia grew by only 1.4%,
which is the lowest recorded annual growth since 2009. The rate of unemployment increased
from 5% to 5.3% in August 2019 and inflation rate remained less than 2%. Thus, to stimulate the
economy and achieve the target inflation rate of 2 to 3%, the central bank took the monetary
policy of reducing the cash rate by a total of 0.75% points, which is lowest in the past 2 years
(Rba.gov.au (a) 2019).
This move by RBA is meant to boost the economic growth of Australia. The cash rate is
the lending rate of the overnight cash funds and lowering this rate increases liquidity in the
money market. It helps in setting the short and medium term rate of interest in the market, and
stimulates the purchasing power of the people, which results in increased money supply in the
economy. When the inflation is low, RBA cuts the cash rate to increase lending as well as
spending, thereby increasing the demand for goods and services and the level of production, that
is, GDP. Similarly, employment and unemployment levels indicate how well the Australian
economy is performing and how much the job opportunities are increasing (Nguyen and Wang
2019). Thus, when the unemployment level in the economy is increasing, as observed in the 3rd
quarter of 2019, lowering cash rate is beneficial as that would stimulate the spending and
investment, which lead to job creation and increased money flow.
Thus, it can be said that cash rate movements affect the term deposits, savings accounts,
asset values and yields. Decrease in cash rate encourages people to spend more and save less as

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the amount of interest on the deposits reduces. It helps to ease the tight liquidity within the
economy by increasing money supply, which in turn yields unattractive returns on the savings
and deposits. Thus, the asset values and yields are reduced due to the fall in cash rate by RBA.
2.3 Importance of leverage
As highlighted by Greber and Shapiro (2016), Glenn Stevens was the RBA Governor
from 2006 to 2016, and he was successful in achieving a positive economic growth for Australia
even during the Global Financial Crisis of 2008-09. The nation experienced a lowering inflation
level since 2011, although it increased during 2014, but 2015 onwards, the continuous low level
of inflation (below 2%) has been a concern for the economy. This encouraged Stevens to aim for
inflation targeting of 2% to 3% in the medium term. The AUD also depreciated against the USD
and the benchmark rate for 10-year government bond decreased to 2.3%, which was slightly
higher than the all-time low of 2.27% in February 2015. Thus, further slower growth of the
economy was predicted at least till mid-2018 and that was alarming. It was highlighted by the
former RBA Governor that if inflation rate did not reach near the target inflation, the production
level would be hampered significantly, unemployment would increase further and investments
would fall due to currency depreciation (Bean et al. 2015). Thus, it was important to increase the
purchasing power of the people, which would stimulate the money flow and domestic demand.
Hence, as per Stevens, the economy needed a push to achieve the inflation target.
Stevens mentioned in 2016 that leverage in the economy was significant. The concept of
financial leverage says that it is beneficial for boosting the returns on the equity capital,
specifically in the cases where operational efficiency and returns on the total investments are low
(Greber and Shapiro 2016). Hence, benefits of leverage can be experienced when the earnings
are higher than the debt costs, and it is negative when the earnings in the economy are lower than

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the costs of securing funds. Financial leverage is also known as the method of borrowing of
capital for making investment with the expectation that the profits would be higher than the
interests paid on the debt (Ahmad, Salman and Shamsi 2015). Thus, it can be said that financial
leverage encourages two way money flow in the economy, and when the level of growth in an
economy is slow, financial leverage can boost the growth through borrowing and spending by
the investors. A lower rate of interest rate would encourage the investors to borrow more money
for the investment purposes with the expectation that the interests on borrowed funds would be
lower than the profits to be earned, thereby improving the asset values and achieving growth.
Hence, according to Stevens, leverage was important for Australian economy (Yarba and Güner
2019).
2.4 Impact of monetary policy on securities values, individual’s personal savings accounts,
investment in superannuation and/or managed fund investments
Securities refer to the financial instruments with monetary value that can be traded
(Gitman et al. 2015). The current monetary policy involves a cut in the cash rate, that lowers the
interest rate in the entire economy. Interest rate has a negative correlation with bond or securities
values (Hunt and Terry 2018). When the interest rate goes down, the security values or bond
prices go up and vice versa. Hence, as the cash rate is reduced, the securities values in Australia
would go up.
Lower interest rate discourages people from saving as the return from the deposits get
lower and thus, level of spending in the economy gets increased. The investment on the
superannuation would also decrease as the return decreases from deposits. On the other hand,
investment in the managed funds would increase as falling interest rate would increase the return
and lower the cost of borrowing (Aizenman, Cheung and Ito 2019).

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2.5 Functionalities of Authorised Deposit Institutions (ADIs) and role of Basel accord ii, iii
or iv (proposed) in dealing with capital and liquidity risks in Australia
The Authorised Deposit-taking Institutions (ADIs) are financial institutions granted by
the Australian Prudential Regulation Authority (APRA), which are permitted to accept deposits
from the people (Akhter and Hasan 2015). These include banks, credit unions, life insurance
companies, private health insurance, general insurance, non-operating holding companies,
superannuation institutions, registered financial corporations and building societies
(Austrac.gov.au 2019). Thus, some non-bank financial institutions are also included under the
ADIs, approved by APRA. There are some strict guidelines and regulations for the ADIs and
while dealing with liquidity, credit, operating and interest rate risks. There are norms like APS
210 Liquidity that enable these institutions to manage liquidity ratio and risks through a risk
management framework. Under credit quality management, there are various norms to be
followed, and a similar procedure is followed for the other types of risk management. According
to the regulatory arrangements made in November 2013, some ADIs need to maintain ES funds
in the accounts as a buffer against the intraday payments and those payments are needed for
settling after the close of interbank cash market (Authority A.P.R. 2017). Size of the buffers is
agreed upon with RBA and the funds are used to pay the interests for achieving target cash rate.
All these balances and funds held by the ADIs under the regulatory frameworks and
arrangements are sourced directly through all types of transactions between RBA and the ADIs,
and the rate of funding of these transactions is determined according to the target cash rate. Thus,
the ADIs deal with the sensitive and crucial variables like credit, liquidity, operating and interest
rate risks through the agreements on ES funds with RBA. The supply and stock of ES funds vary

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as per the transactions, such as, purchase of banknotes from RBA by the ADIs, buying or selling
of debt securities from the financial institutions by the RBA etc. (Fox 2016).
Basel Accords are the banking supervision accords, that is, recommendations on the
banking supervision and regulations and there are four segments of the accords, namely, Basel I,
Basel II, Basel III and Basel IV. These are issued by the Basel Committee of Banking
Supervision (BCBS). Basel I is based on credit risk and relevant risk weighting of the assets,
Basel II consists of recommendations on banking regulations issues. Basel III includes
regulations on market liquidity risk, capital adequacy, and stress testing and Basel IV covers the
aspects of credit risk, securitization, counterparty credit risk, market risk, operational risk, step-in
and other risks (Mohammed Ahmed 2016).
3.0 Conclusion
The above discussion provides an outline of the recent monetary policy in Australia, its
impact on asset values, yields, security values, deposits of various types, significance of
leverage, role of RBA and ADIs, and the role of regulations, that is, Basel Accords. It can be
inferred that the move in the monetary policy by RBA, that is, a dramatic cut in the cash rate to a
historic low is aimed at stimulating the economic growth by increasing the purchasing power and
disposable income of people, making borrowing easy, increasing the scope of investments,
domestic demand and employment and, therefore, increasing money supply in the economy. On
the other hand, this move will affect the savings and all other types of deposits negatively as the
returns would decrease. The security values would increase, while asset values would decrease.
The environment is regulated by RBA and other ADIs, granted by APRA. The regulatory
frameworks are determined by RBA and other authorities, through various regulatory Acts, like

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Basel Accords, which are designed to control the credit, liquidity, operational and interest rate
risks, and keeping it closer to the target cash rate. It has been observed that leverage was
necessary for the economy to push the growth and achieve target inflation.

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