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The reason the Reserve Bank Of Australia (RBA) reduced the cash rate by 25 basis points from 5% to 4

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Introduction

Duff beer MACROECONOMICS 102 ESSAY The reason the Reserve Bank Of Australia (RBA) reduced the cash rate by 25 basis points from 5% to 4.75% is because of concerns over the extent of the economic downturn in the global economy and the likely flow on effects it will have on Australia. I will answer this question in two parts, firstly considering what the RBA feared would happen if the cash rate wasn't cut and secondly considering the effects on the Australian economy of an interest rate cut. The forecasted longer than expected global downturn in major economies like the US, Japan and European Union, has the RBA expecting similar flow on affects in Australia unless expansionary monetary policy is implemented. The RBA was worried that aggregate demand would fall to levels that may risk a recession or a prolonged slowdown in Australia. ...read more.

Middle

[AFR 6/9/01] A reduction in interest rates will increase aggregate demand and boost economic growth through the following ways: A reduction in interest rates (i/r) will reduce the cost of borrowing for business investment, makes business ventures appear more profitable, increases investment=>AD & AE. Also lower i/r's signals price stability and less chance of inflationary pressures being a concern in the economy, which also increases the likelihood of investment being undertaken by businesses. A reduction in i/r's will reduce mortgage repayment loans, therefore increasing the consumer's level of disposable income=> increasing C=> increasing AD & AE. A decrease in i/r's will cause foreign investment funds to be withdrawn from Australia (capital outflow) which results in a decrease in the demand for the Australian dollar ($A), therefore depreciation of $A. ...read more.

Conclusion

With the attraction of lower mortgages predicted to push up asset prices, as the demand for houses increases due to lower i/r's, inflationary expectations still remain low. In the area of Fiscal Policy, the introduction of the GST has created additional tax revenue for the government intent on achieving Fiscal consolidation, which reduces demand-pull inflationary pressures in the economy. The RBA feels it will be able to maintain low inflation also due to downward pressures from a weakening export sector and global economy. The depreciation of the Australia dollar due to the rate cut will naturally cause imported inflation but that will be more than off-set by a slowdown in expected export growth. The RBA is focused on reducing the expected size of fluctuations in output, rather than focus solely on inflation. All these signs point the RBA to cut the cash rate by 25 basis points to 4.75%. ...read more.

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