Answer to Question #16177 in Economics of Enterprise for a n m

Question

The Reserve Bank of Australia is preparing to reduce interest rates in the near future. Why does the Bank want to do this? What is the Bank’s overriding target?
If the bank does raise interest rates how would it affect the Australian economy?

Answer 1

Interest rate acts as a fee for the use of borrowed funds. The effect of the interest rate is linked to the fact that between the level of prices in the economy and the level of interest there is a definite relationship. The growth of prices in the economy at a constant value of money in circulation, increases the demand for money. This means that the price of money - interest rates - increases. As a result, consumer and investment components of aggregate demand decrease - because of the high interest rate investment business activity falls on the other hand, the high interest rate is an incentive for people to save more, which is only possible by reducing consumer spending. That's why, the Reserve Bank of Australia is trying to lead Australian term deposit rates to lower levels. If the bank raises the interest rate, then majority of bank funds will be "frozen" in the accounts of the central bank and can not be used by commercial banks for a loan. This reduces bank loans and money supply, increased interest on bank loans.&