• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Macroeconomics- Demand and Supply of Money, Monetary Policy and Whether the Australian Government should tighten monetary policy.

Extracts from this document...


(i) Discuss the main economic factors that influence the demand for money? The demand for money is the amount of wealth an individual chooses to hold in the form of money. In any household or business the demand for money will depend on a variety of individual circumstances (Bernanke, Olekalns, Frank 2009, p. 86) The demand for money incorporates Transaction Demand which consists of currency (notes and coins) and bank deposits and Asset Demand which compromises financial assets (e.g. Bonds) and is dependent on the level of interest. While businesses and individuals vary considerably in the amount of money they choose to hold, there are 3 main economic factors which influence the demand for money. a) The nominal interest rate (i) The interest rate paid on alternatives to money determines the opportunity cost of holding money. The higher the prevailing nominal interest rate, the greater the opportunity cost of holding money, and hence the less money individuals and businesses will demand. b) The Price level (p) The higher the price of goods and services, the more dollars are needed to make a given set of transactions. ...read more.


This can be seen in the upward sloping yield curve. Changes in the cash rate aims to curb inflationary pressures in the medium-long term and this can be done by using the tools of monetary policy, which influences the supply of ESA funds to ensure that the demand & supply for the ESA funds are kept in balance to meet the required cash rate. Exchange Settlement Accounts(ESA) are accounts kept by banks with the Reserve Bank to settle debts owing to other banks which arise as result of exchange of cheques and to provide funds on which to draw additional notes and coins. Two main tools to control cash rates are open market operations and Foreign exchange swaps. 1. Open market operations: * The buying and selling of government securities by the RBA in short-term money market. * When the RBA increases cash rate by selling government securities, the bank's reserves fall, decreasing credit, decreasing investment, therefore decreasing aggregate demand. * Conversely, when the RBA decreases cash rate by buying government securities, the bank's reserves rise, increasing credit, increasing investment, therefore increasing aggregate demand 2. ...read more.


There are inflationary pressures of P1 to P2, and the short run equilibrium (QE) output exceeds that of 'potential' output (QP). With reference to the diagrams above - Tight monetary policy works by: 1. Announcing the target cash rate from CR1 to CR2 and shifting supply of ESA funds to the left from S1 to S2, decreasing credit availability. 2. This affects other interest rates in the money market such as the 3 year fund - increasing interest rates from R1 to R2 decreasing money supplied from SF1 to SF2. 3. The rise in interest rate also affects investment demand. As the rise in interest rate from R1 to R2 shifts investment from I1 to I2 4. Impacting on the aggregate demand curve to shift to the left from AD1 to AD2. * However effectiveness of monetary policy depends on the shape of the demand for money curve and shape of the investment demand curve. Reference List Bernanke B., Olekalns N., Frank R., 2009, Principles of Macroeconomics: 2nd Edition, Australia, McGraw-Hill Irwin Australia Pty Ltd Stevens G., Monetary Policy and Inflation: How Does it Work?, Remarks to the Australian Treasury Seminar Series Canberra - 11 March 2008 'About Monetary Policy'- RBA 2001-2009 ?? ?? ?? ?? ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our University Degree Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related University Degree Macroeconomics essays

  1. What is the relationship between money supply and inflation?

    effective money supply as it excludes the most important source of liquidity for spending, which are namely bank deposits. To tackle a problem one must get to the root of the problem. This is where Goodhart's Law comes into play.

  2. Explain how monetary policy works under an inflation targeting regime

    In the case of a significant difference from the target, the Central Bank shall clarify the reasons in its reports to the public, following the said development in the framework of the inflation-targeting regime. In this situation, the Central Bank will continuously be obliged to report for its actions to the public.

  1. Fiscal policy is powerful while monetary policy is weak. Discuss.

    In a recession firms are very nervous that they may go out of business so they are unlikely to invest in capital so that they can meet future orders. Regardless of interest rates firms will be adverse towards investing.

  2. An argument against optimum currency areas (OCA) is that the single currency and the ...

    The firm, being part of a perfectly competitive market (one encompassing a large number of relatively small firms in competition with one another), can sell all of its output at the market clearing price, and is a price taker since its output is a tiny part of the market's output

  1. Explain the concept of Price Elasticity of Demand and discuss its relevance for Business ...

    Yet some individual sellers may experience perfectly elastic demand in certain conditions. The perfectly elastic demand curve is more associated with the perfectly competitive market, where no single seller would be able to influence the market price. If the seller decides to charge a higher price, then they would lose all their customers due to other sellers offering homogenous goods.

  2. Economics Questions on National Income, Aggregate Demand and Business Cycles.

    1. Put forward by Adam Smith 2. Believes that every country has an absolute advantage in supplying certain products 3. Hence, the country must specialise in export of those products only 4. It should import goods from countries, which have an absolute advantage in exporting the products, and hence get them at a cheaper rate 5.

  1. The purpose of this coursework is to study the characteristics of inflation in the ...

    regulation of production, since the rise in prices is the inevitable result of the underlying processes in the economy, an objective consequence of the growth imbalances between supply and demand, production of consumer goods and capital goods, the accumulation and consumption, etc.

  2. Commentary. The article proposed a dilemma that State Bank of Pakistan (SBP) is facing ...

    The previous five year experience of increasing the interest rate is proved futile as higher interest rate for this much time has hindered the economic growth of the country. The industry is getting closed; unemployment at the peak and the inflation still could not be brought to a single digit.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work