Question

explain the expansionary and contractionary monetary policy graphs as to how an increase in the cash rate from 1 % to 1.5% would help to keep inflation within the target rate, and how a further decrease from 1% to 0.75 % in the cash rate would help to stimulate the economy. Describe the circumstances in which the RBA Board might decrease and/or increase the cash rate in the future

Answer 1

The cash rate is the rate at which the RBA lends to commercial banks in the overnight money markets. Increasing the cash rate from  1% to 1.5% would make borrowing more expensive for commercial banks and hence the commercial banks would also increase their interest rates. An increase in interest rates would keep inflation under check as a higher cash rate leaves consumers with less available income to save or spend due to higher interest payments on loans etc.

A lower cash rate translates into lower interest rates throughout the economy thus stimulating consumer spending and investments. This increases into higher production and higher levels of national output.

In the future the RBA would raise the cash rate, if there is too much demand and if the rate of inflation is on the higher side. Higher interest rates tend to act as brakes for lending growth, which has a downward effect on demand and inflation. In times when the Australian economies is slowing down and needs a boost, the RBA can lower cash rate to stimulate the economy.