Monetary Policy refers to the changing of interest rates to counter balance changes in the

economic cycle, predominantly to maintain low inflation 2-3%. Interest Rates are regulated by
the Reserve Bank of Australia and is the cost of borrowing funds. Monetary Policy can have two
stances, either tightening or loosening. The RBA will tighten monetary policy which is
contractionary in order to decrease economic growth and lower the rate of inflation. A
loosening policy is expansionary and results in lower interest rates and is used to stimulate
economic activity. The RBA tightens and and loosens economic activity within Domestic Market
Operations by selling and purchasing commonwealth government securities within the short
term money market. The RBA is the banker to the banks, banks such as Anz, Nab and CBA etc.
use Exchange Settlement acconts, these are places where small amounts of money is stored in
order to settle transactions between banks due to consumers using different banks, the esa is
the short-term money market, as settlements are made overnight. Within the ESA there is a
cash rate that is consistently changing which ultimately determines interest rates, the cash rate
is affected by the RBAs influence of buying and selling securities. AS the RBA purchases
securities they are increasing the supply of money into the money market, the money is added
to the exchange settlement accounts, due to the large supply in respect to the equilibrium the
increase in supply will result in lower cash rates and to maintain margins, banks lower interest
rates, consumption will increase as it costs less to borrow funds ultimately resulting in greater
economic activity. In an alternative respect the RBA would sell securities which means that
money is going out money market, the supply of money decreases, therefore with cash rate will
rise and ultimately banks will raise interest rates in order to maintain the margins, banks higher
interest rates. The higher interests will result in lower consumption due to higher costs of
borrowing and higher risk of investment. This will ultimately result in a decrease the level of
economic activity.