Macroeconomic - Market Rate of Interest - Essay Example

The cash rate can be changed by the mortgage as well as the rates of business loans. The aggregate economy is often influenced by monetary policy. Suppose the Reserve Bank deals in supplying more money to the commercial banks, those banks will attempt to keep the reserve rate at steady level and launch into lending more cash in the market. This will lead to a fall in the cash rate. The supply of funds can be increased by increasing the average maturity of the repos, expanding the private security ranges.

The changes in the monetary policy will shed its effects on the interest rates in the short run and thus the relationship between the cash arte and the interest rates can be easily defined. But it should be kept in mind that the cash rate lacks the potential to determine the level of intermediary’s rates (Campbell, 1997). 2. Analyze the effects of a decrease in the interest rate on consumption and investment expenditures, the level of aggregate demand, the inflation and the unemployment rates.

Answer: The changes in the interest rates can shed effects on the consumption spending. With increase in the price levels the interest rates tends to increase. . On the other hand the expenditures on consumption will decrease. Aggregate demand is expressed by AD = C + I + G + (X-M), where C= consumption, I= capital investment, G= government spending, and (X-M) = trade balance. When the interest rate falls, the capital investment rises and therefore the aggregate demand rises. The effect is just the opposite for rise in the level of interest rates.

If the interest rates fall, the demand prevailing in the society for the goods as well as services will fall. Therefore the prices of the products will tend to fall being the resultant of fall in price. Decrease in demand will lead to less production and eventually unemployment rises. 3. Explain what is the meant by the credit creation process of the commercial banks and how it may be influenced by the expansionary monetary policy. Answer: The primary functions of banks include acceptance of deposits, remittance of funds, advancing loans, creation of credit and financing foreign trade.

Creation of credit is one of the unique functions of the bank. It is the responsibility of the banks to supply money to the traders as well as to the manufacturers. The banks are also involved in creating or manufacturing money. The deposits of the banks can be regarded as money. Such deposits can be compared with cash. The deposits can be used in purchasing goods as well as services. They can also be used in debt payments. The deposits of the customers are called primary deposits. The banks keep a certain part of the deposits in the form of reserves while the rest is made available for loans advancements.

Therefore every deposit has the potential to create loan. The banks do not pay cash to the customer when it grants a loan to them. The bank simply credits the requisite or the loan amount in the