The factors determining movements in the general level of variable and fixed term interest rates in Australia
Introduction
There are several factors influencing the movements in interest rate. Therein, change in monetary policy influence the variable rate directly. Fixed rate are always determined by both the variable rate and international rates. To analyze the change in interest rate, several factors, such as monetary policy, inflation, exchange rate and international interest rate should be mentioned.
Supply vs. Demand of money
Savings are the supply of money, and the demand of money means borrowing. Normally, supply of money has direct ratio with the interest rate. Once interest rate increases, supply of money will increase as well. In the opposite position, increase in interest rate leads to less borrowing. The intersection of the supply and the demand curve for funds indicates the equilibrium point.
If there is the rise on propensity to save, the supply curve of savings shifts to the right (S1) which leads to the lower interest rate, and vice versa (S2).
The demand curve shifts upward once more demand of the funds and the interest rate increases (D1). Conversely, less borrowing makes the demand curve shift to left and higher interest rate (D2).
Change in Monetary Policy
Monetary policy is conducted by Australia Central Bank, The Reserve Bank of Australia (“RBA”). The target for monetary policy is set in terms of the consumer price index. The objective is to achieve an average rate of CPI inflation of between 2 and 3 percent. Monetary policy involves control over the money supply and interest rates with a view to influencing aggregate demand, employment and inflation.
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