EXPLORING YOUR OPTIONS Dr Frédérique Bracoud WHAT’S THE FUSS ABOUT THE CASH RATE?

The fuss…. 2.00% Cash rate target

What is the cash rate? The cash rate is the interest rate on A.RBA loans to commercial banks. B.mortgage loans to households. C.loans among banks. D.deposits that banks have at the RBA. Not obvious for some people ….. even for chief economists in banks ….. or Wikipedia!

Overnight interbank interest rate interest rate Bank ABank B $1,000,000 Bank ABank B $1,000,055

Central bank money The funds that banks lend to each other are very special. █NOT notes and coins █NOT balances in commercial bank deposit accounts █They are balances in deposit accounts at the RBA can only be transferred among banks, to the government or to the RBA $ RBA

Behind the scene all the time! Mobile phone monthly bill paid by Will (bank account at Bank B) to the Mobile phone provider (bank account at Bank C) Will’s bank account Mobile Phone provider’s bank account $45 $ Bank B Bank C $45 $ RBA

What if Bank B has not enough money? Bank C Payment system RBA Bank B Bank A Interbank Market

Interbank rate is a major cost for banks banks When the RBA changes the cash rate, █the costs of banks are affected █banks need to adjust the rates on their loans (housing loans, personal loans, student loans….) in order to maintain their profit margins.

Historical low 2.00% High 7.50% Your life

Your Samsung Galaxy S6 may be at risk! If your parents have a $300,000 mortgage loan, an increase in the loan rate by 0.50 percentage point will cost your parents approximately █an extra $100 a month in repayments █an extra $500 dollars in repayments between August and Christmas! Your parents may decide to buy you SOCKS instead of a Samsung Galaxy S6!

Transmission of monetary policy Cash rate Bank interest rates Exchange rate $ Financial markets rates Consumption spending Economic growth Inflation Business spending Net exports Spending on new Housing

Who decides the cash rate? Commercial banks freely choose the cash rate. The RBA cannot impose the cash rate on private contracts. What’s the trick then?

The trick █The RBA does not choose the cash rate in the private █contract but chooses a target, a desired level █The RBA manipulates the stock of central bank money every day █The RBA can create situations where banks do not have enough or where banks have too much central money █The RBA affects the conditions in the interbank market and the cash rate RBA

Demand and supply of central money Cash rate Quantity of central bank money Cash rate target: 2.00% Cash rate chosen by banksS SDSD S

The fuss about the cash rate is because… … the cash rate is the first target of monetary policy. It affects the interest rates and the exchange rate and ultimately the economic activity and inflation.

Tuesday 4 th August 2015 Be prepared! 1.5%, 2.00% or 2.5%? or

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