Piecing together monetary policy (1 Viewer)

[swagmeister]

Heyo,

We did macro really quick so I don't really get how monetary policy comes together.

Like, I get the Exchange Settlement Accounts with the RBA bit and then their is the domestic market operations through buying and selling Commonwealth Government Securities, but how do these to things work in tandem to allow the RBA to achieve their desired cash rate?

 

[Mikes]

When the RBA buys second hand government securities, it increases the supply of loanable funds in the short term money market. As with any markets, as supply increases, price falls, placing downward pressure on the cost of borrowing money - i.e., the cash rate. Banks pass this on as lower commercial interest rates in order to remain competitive (transmission mechanism). The converse holds true as well; to increase the cash rate, the RBA sells government securities, which decreases liquidity and the supply of funds, increasing price.

 

[swagmeister]

When the RBA buys second hand government securities, it increases the supply of loanable funds in the short term money market. As with any markets, as supply increases, price falls, placing downward pressure on the cost of borrowing money - i.e., the cash rate. Banks pass this on as lower commercial interest rates in order to remain competitive (transmission mechanism). The converse holds true as well; to increase the cash rate, the RBA sells government securities, which decreases liquidity and the supply of funds, increasing price.

Cheers man. Two quick things

1) where does the exchange settlement accounts fit in
2) by buying second hand government securities doesn't that increases the demand, not supply, and shouldn't this decrease the liquidty on the market cause they are buying not selling?

 

[Ekman]

Cheers man. Two quick things

1) where does the exchange settlement accounts fit in
2) by buying second hand government securities doesn't that increases the demand, not supply, and shouldn't this decrease the liquidty on the market cause they are buying not selling?

1- The exchange settlement accounts are the accounts owned by domestic bank accounts with the RBA. Each bank has the ability to access the loanable funds in the short-term money market through these ESA's and they also allow the RBA to control the level of money liquidity with domestic banks, through the buying and selling of government securities.

2-I know that the whole idea of buying and selling government securities is a little hard to grasp, so ill try explaining the best that I can. If you were the RBA, and you decided to sell government securities (another way to look at it, is by saying these 'securities' are just 'pieces of paper') to any financial institutions (aka domestic banks), you expect money for that 'piece of paper'. So as you sell the security, you get money in return, resulting in a decrease in supply of money in the short term money market. The opposite works as well. As the RBA, when you want to decrease the interest rates, you buy back your securities or 'pieces of paper' from the domestic banks, meaning you put money back into the short term money market, in return for your security, and you increase the supply of money.