Modern Macroeconomics Commercial Banks

Question: Describe about the Modern Macroeconomics for Commercial Banks. Answer: 1. Cash rate may be defined as the rate of interest at which overnight loans are extended to commercial banks. At this rate, the Reserve Bank of Australia lends money to the various commercial banks for one night only and the money needs to be paid back with the applicable interest at the start of the next business day (RBA, 2016a). 2. The suitable mechanism used by the RBA to ensure that the cash rate remains at the desired level is through open market operations which are utilised to either squeeze excess liquidity from the system or to inject incremental liquidity in the system as may be the case. In case of shortage of liquidity, the RBA would buy the government bills and bonds from the commercial banks so as to provide them with higher liquidity and hence preventing the cash rate from rising (RBA, 2016b). 3. Target CPI rate set by RBA is 2-3% pa (RBA, 2016a). 4. In inflation is below the target rate, it is likely that the cash rate would be decreased so as to ensure that loans become cheaper thus enhancing the aggregate demand which would lead to higher inflation and therefore the RBA target would be met. However, there would be time lag involved in the implementation of the same (Koutsoyiannis, 2013). 5. Quantitative Easing (QE) refers to an unconventional monetary policy adopted by central banks in recessionary times to provide an impetus to the economy. It involves the purchase of various securities (including those which are toxic) by the central bank in order to enhance the overall liquidity in the system (Koutsoyiannis, 2013). Due to QE, there would be higher amount of money available to the various funds which would deploy this money into buying into securities issued by the various corporate entities. As a result, the borrowing costs would decline for the corporate sector which would provide greater incentive for corporate sector to enhance production which would lower prices and increase demand and hence fuel inflation (BoE, 2014). 6. Negative interest rate refer to a situation when the depositors instead of deriving interest on the deposits made in the bank would actually have to pay money to park money in banks. When QE also does not lead to an economic stimulus coupled with zero interest rates, the central banks resort to negative interest rates whose major purpose is to enhance consumer spending and end up any incentive to save for future consumption so that aggregate demand is increased and economy gets a stimulus (Koutsoyiannis, 2013). References Koutsoyiannis, A 2013. Modern Macroeconomics, 4th edn, Palgrave McMillan, London RBA 2016a, Inflation Target, RBA Website, Available online from https://www.rba.gov.au/inflation/ (Accessed on October 13, 2016) RBA 2016b, Open Market Operations, Available online from https://www.rba.gov.au/mkt-operations/resources/tech-notes/open-market-operations.html (Accessed on October 13, 2016) BoE 2014, Money creation in the modern economy - Quarterly Bulletin article, YouTube, Available online from https://www.youtube.com/watch?v=CvRAqR2pAgw (Accessed on October 13, 2016)