The Relationship Between Inflation and Nominal Interest Rates - Assignment Example

Question 2(d)

From the graph series, it can be ascertained that the cash target rate possesses an indirect level of relationship with the consumer price indices for the period between 1990 and 2015. The relationship portrays a significant quarterly increase in the values of CPI while the cash target rate decreases at almost a similar level. The decrease in cash target rates indicates that the Australian Reserve Bank is making efforts to increase the overnight lending made to commercial banks hence trigger lots of money supply in the market necessary for conducting transactions. It is important to note that the target rate does not rely on transactions made by Australian commercial banks rather by the sale or purchase of such government-issued securities as bonds, which affect the supply of money in the market that posits direct influence on interest rate changes in both long and short term periods. In fact, since the Reserve Bank is tasked with the responsibility of overseeing and reviewing cash rate targets on an overnight and monthly basis, the rate of short term interest rates changes significantly to reflect the availability of money supply in markets.

Cash target rates influence the price attributed to the borrowing of money and thus, it avails the Reserve Bank with a way of controlling the level of economic activities as well as inflation levels. The cash target rate movements seem to have little or no influence on interest rates charged on government-issued bonds over the entire period. This is attributed to the fact that most of these market interest rates; whether long or short term are held around the cash target rates set by the Reserve Bank of Australia. In essence, because the interest rates remain relatively constant within these long term periods that is the reason behind increased consumer price indexes and inflation for that matter.

It is important to realize that in case of interest rates increase, most people will cut their respective spending habits on both goods and services. This is attributed to the fact that savings attract higher interest rates while participation in loans attracts exorbitant interest payments. As a result of saving more and spending less, there is less pressure exerted on the consumer price index (CPI) to increase and thus, the aspect of inflation will always tend to reduce significantly. This is clearly shown by the ever-increasing CPI values as opposed to decreased cash target rates.

Question 2(e)

The Reserve Bank of Australia gives a number of reasons for the change of target cash rates in the period between 1990 and 2015. These reasons include;

In November 2006, the board decided to increase the cash rate to 6.25 percent. The reasons given for this increase include a continued growth in the global economy and a certain postulation that there was going to be increased inflationary pressures. The increase is also attributed to expanded domestic demand in labor markets and a moderate increase in the demand for credit.

In the 2010 period, the RBA decided to maintain the target cash rate at 4.75. The stable improvement in the cash target rate is attributed to increases in terms of trade for Australia since the 1950s and thus, there has been significant growth in national income. Consequently, due to the favorable terms of trade, private investment is deemed to have increased in regard to the high levels of commodity prices. Secondly, there has significant employment growth over a substantial number of years, which has directly affected the improvement of wages. Thirdly, the statements note that there has been significant improvement in the country’s currency exchange rates, which has, in turn, affected commodity prices. The effect is said to have assisted in containing the level of pressures attributed to inflation over the periods ahead.