Interest rate deterimination lecture

Interest rate deterimination lecture - CAPITAL MARKETS AND...

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1 CAPITAL MARKETS AND INSTITUTIONS An Introduction to Interest Rate Determination and Forecasting
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2 5 Sector Economy 5 sectors are…. The role of government sector The economic prosperity and welfare of the people of Australia Policies to implement its MACRO-economic objectives Fiscal policy Monetary policy Reserve Bank Interest rate
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3 Learning Objectives Explain why a central bank uses interest rates to implement monetary policy Describe the short-term and long-term impacts of a change in interest rates Outline approaches explaining how interest rates are set Explain yields, yield curves and term structures of interest rates Describe theories of the shape and slope of a yield curve Explain the risk structure of interest rates and the impact of default risk on interest rates
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4 Chapter Organisation 13.1 Macroeconomic Context of Interest Rate Determination 13.2 Loanable Funds Approach to Interest Rate Determination 13.3 Term and Risk Structure of Interest Rates 13.4 Summary
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5 13.1 Macroeconomic Context of Interest Rate Determination In most developed economies monetary policy actions are directed at influencing interest rates By understanding what motivates a central bank in its implementation of interest rates policy Financial market participants can anticipate changes in a government’s interest rate policy Lenders and borrowers can make better- informed decisions
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6 The Reserve Bank in determining IR The stability of the currency The maintenance of full employment The economic prosperity and welfare of the people of Australia
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7 13.1 Macroeconomic Context of Interest Rate Determination (cont.) A central bank may increase interest rates if there is Inflation above target range Excessive growth in GDP A large deficit in the balance of payments Rapid growth in credit and debt levels Excessive ‘downward’ pressure on FX markets
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8 13.1 Macroeconomic Context of Interest Rate Determination (cont.) An increase in interest rates (i.e. tightening of monetary policy) will Eventually increase long-term rates Slow consumer spending Reducing inflation and demand for imports Decrease the size of the current account Possibly attract foreign investment causing the domestic currency to appreciate
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9 13.1 Macroeconomic Context of Interest Rate Determination (cont.) Three effects of changes in interest rates Liquidity effect The affect of the RBA’s market operations on the money supply and system liquidity e.g. RBA increases rates (i.e. tightens monetary policy) by selling CGS Income effect A flow-on effect from the liquidity effect If interest rates rise, economic activity will slow, allowing rates to ease Increased rates reduce spending levels and income levels
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10 13.1 Macroeconomic Context of Interest Rate Determination (cont.) Three effects of changes in interest rates (cont.) Inflation effect As the rate of growth in economic activity slows, demand for loans also slows This results in an easing of the rate of inflation
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11 13.1 Macroeconomic Context of Interest Rate Determination (cont.)
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