ECON 1102 Week 7 post lecture

Rule banks are not allowed to overdraw their esa ie

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Rule: Banks are not allowed to overdraw their ESA, i.e. they must always be in credit. 64
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Provide a means by which banks can clear any payments among themselves. If ANZ owes $20m to Westpac, then funds are simply transferred between their ESAs. These types of interbank transfers will change the distribution of cash , but will not affect the overall level of cash in the system. What happens if ANZ finds its level of cash holdings to be undesirably low? 65
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There is a specialised market where banks are able to trade cash . Overnight cash market Borrowing and lending for periods up to 24 hours ANZ could borrow cash from some other bank which might find itself with more than it wants to hold. The interest rate that clears this interbank market is the overnight cash rate and it this rate that the RBA chooses to target. 66
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While the actions of the banks cannot change the level of cash in the system, the actions of the RBA can. RBA can buy and sell bonds (typically government bonds) from/to the banks. If the RBA buys bonds it pays for the bonds by crediting the bank’s ESA. If the RBA sells bonds it receives payment by debiting the bank’s ESA. 67
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The action buying and selling bonds is known as Open Market Operations (OMO). Open market operations provide a means by which the RBA can influence the overall level of cash (exchange settlement funds). They also provide the means by which the RBA is able to ensure the overnight cash rate is equal to its target rate. 68
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If there is excess cash in the system so that there is pressure for the cash rate to fall below 3.0%, RBA will sell bonds and this will reduce the supply of cash. If there is a shortage of cash in the system so that there is pressure for the cash rate to rise above 3.0%, RBA will buy bonds and this will increase the supply of cash. 69
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Monetary policy seeks to affect all interest rates in the economy, not just the overnight cash rate. Longer term interest rates do tend to track the cash rate quite closely. Interest rates decreasing on the overnight cash rate would attract longer-term loan money, which would tend to decrease the interest rate in those longer-term markets. Vice versa for an increase in interest rates.
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At its monthly meeting the RBA board of governors decides what changes, if any, shall be made to the cash rate. Financial markets follow these meetings with intense interest because the outcome immediately influences most interest rates and the bond, share and housing markets. Having set the cash rate, the RBA conducts open market operations to achieve it.
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Figure 7.2 Interest rates
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