Domestic Market operations by the Reserve Bank

Mr.Sassine

What are Domestic market operations?

• Domestic market operations are actions by the Reserve Bank of Australia in the short term money market to buy and sell securities-either outright or through re-purchase agreements- in order to influence the cash rate and the general level of interest rates.

Lets revise

1-What are domestic market operations?

Stephen Jordon Bosley

Nathan Wild

What happens?• DMOs refer to the sale and purchase of sales and securities

such as second-hand commonwealth Government securities (Treasury bonds and notes that have been issued by the reserve bank previously) for the purpose of influencing interest rates.

• The general level of interest rates will effect the level of economic activity in an economy.

Lets revise

• The general level of interest rates will effect the level of economic activity in Australia T OR F

• Samantha • Bianca• DMOs do not refer to the sale and purchase of sales and

securities such as second-hand commonwealth Government securities T OR F

• Ashleigh • Caitlin

• It is important to note that debt financing is a tool used by the government to finance government deficits. Governments use debt financing when new government securities are used to finance budget deficits. The government here is simply borrowing money from the public and spending it (through an increase of taxes)

• Therefore Domestic market operations and debt financing are two separate activities.

How domestic market operations work?

• Domestic market operations are conducted directly with financial institutions , through their exchange settlement accounts with the Reserve Bank.

• Banks need to hold a certain proportion of their funds with the RBA in exchange settlement accounts (ES) in order to settle payments with other banks, and the RBA.

• Look at the RBA as the middle man.

Lets revise

• What is debt financing used for?• Ashleigh• Ugljesa

• How are domestic market operations conducted?Karyna

• Michael

What does this mean?

• For example, when a customer of the ANZ bank, uses a cheque to buy a good or service from a business that has a bank account at Westpac, funds will flow from the ANZ banks ES account to the Westpac’s banks ES account.

• Therefore at the end of each trading day, these settlements between bank will cancel each other out, having no impact on the supply of money.

Short term money market

• The short term money market (also known as the market for settlement funds) is the market where banks borrow money if they need to add to their ES accounts. Banks can also lend money if they have an excess of funds beyond what they need on their ES accounts.

• When the supply of funds held in the short term money market is too high, the price of borrowing this money, the cash rate will fall. Likewise if the supply of funds in the settlement market decreases, the cash rate will rise.

Reducing the cash rate

• If the RBA wants to reduce the cash rate, it will buy securities from commercial banks, and in exchange deposit additional funds in their exchange settlement accounts.

• This increases the supply of settlement funds, which will put downwards pressure on the overnight cash rate. However when the RBA sells securities to a bank it withdraws money from the sellers ES account, subtracting from the sellers total ES balance. As a result, by selling or buying government securities, the RBA creates a shortage or surplus of funds in the short term money market, thus affecting the cash rate of interest.

Tightening or Loosening of Monetary Policy

• As a result, by selling or buying government securities, the RBA creates a shortage or surplus of funds in the short term money market, thus affecting the cash rate of interest.

Tightening and Loosening of Monetary Policy

• During the 1990’s and the 2000’s , lower government debt levels reduced the supply of Commonwealth government securities (CGS), so the Reserve bank shifted from using outright purchases and sales of Commonwealth government securities.

• The RBA started to use re-purchase agreements, and a range of highly rated securities.

• The RBA’S main role is not limited to changing interest rates.

• The demand of banks for ES funds change on a daily basis, the RBA intervenes on a regular basis and intervenes in the short term money market to maintain the cash rate at its target level.

• For example, providing banks with more or less money to maintain the current cash rate.

• The RBA cash rate provide the foundations of the interest rate structure in the economy.

• An increase in the cash rate means that it becomes more expensive for financial institutions to obtain funds in the short-term money market.

• First Tuesday of every month RBA looks at interest rates.

• This increases the overall cost structure of borrowing, eventually flowing through to longer term and mortgage interest rates, as banks try to maintain their profit range.

• Changes in the level of interest rates (caused by changes in the cash rate) impact upon the level of economic activity. If interest rates falls, this encourages consumption and investment spending, which increases the level of economic activity. Injections, in the economy.

• If interest rates rise, this increases consumption and investment spending, and reduces the overall level of economic activity.

Tightening of monetary policy

1. RBA sells securities

2. Shortage of borrowable funds

3. Cash rate

4. To maintain margins, banks increase market rates

5. Consumers and business have to pay more on existing debts, new borrowers find it harder to borrow funds

6. Consumption and investment spending decreases

7. Decrease in economic activity

An increase in Interest Rates will cause the supply curve to shift to the left

Loosening of monetary policy

1. RBA buys securities

2. Excess of borrowable funds

3. Cash rate

4. To maintain margins banks decrease market interest rates

5. Consumers and borrowers have to pay less on existing debts now

6. Consumption and investment spending

7. Economic activity

Loosening monetary policy gives life to the economy: Intended effect

A decrease in Interest Rates will cause the supply curve to shift to the left

Supply curve shifts to the left, excess

amount of borrowable funds due a lower

cash rate.

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