Monetary Policy question

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Hey guys, im having trouble understanding how monetary policy works in manipulating interest rates, specifically how the cash rate can increase in the 'cash market' and how this affects our interest rates.

thanks!

[coolrezaee]

So as we know the cash rate changes daily in the cash market, this is known as the 'actual' cash rate. So what the RBA does to meet the 'target' cash rate (currently 2.5) is to decrease the volume (liquidity) of money in the cash market, this is a case where there is a large volume of cash in the market and the 'actual' cash rate is lower than target rate. The following happens to increase the cash rate:

The RBA increases the cash rate by reducing the liquidity (volume) of cash in the cash market through ‘open market operations’. It does this by enticing banks to give money to the RBA. The RBA sells Commonwealth Government Securities (CGS) or Repurchase Agreements (REPOS) to the banks in exchange for cash. This reduces the volume of cash that banks can lend or borrow between themselves in their Exchange Settlement Accounts (ESAs) thus forcing the cash lending rate between banks to increase.

Hope this helps.

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so because the cash lending rate between banks increases, do banks then pass on these increases through the form of higher interest rates? and how does this relate to a surplus or deficit in ESAs, why do banks want a balanced ESA?

thanks

[Cranium002]

The monetary policy is a process controlled by the Reserve Bank of Australia/ central banks, whom determines the size and rates of growth of the money supply. This process affects the increase/decrease of interest rates. The RBA can sell treasuries to securities to increase interest rates or buy them to decrease interest rates. An increase in interest rates results in lesser spending. On the other side, a decrease in interest rates, increases disposable income, more spending and a higher economic growth. Other factors that is caused by the monetary policy includes stimulating economic growth and lowering unemployment rates. The goal of inflation in Australia is between 2-3%.

Hope this helps