Domestic Market Operations

Domestic Market Operations are the instrument of monetary policy. It refers to the purchase and sale of securities, such as second hand commonwealth government securities by the Reserve Bank, for the purpose of influencing interest rates. The General level of

Interest rates

The rate if interest is one of the most important prices in the economy. It is the price that beings about equilibrium in the financial market, where the quantity of funds supplied by lenders is equal to that demanded by borrowers. If we assume that enders will tend to offer a higher quantity of fund as the interest rate increases, and that borrowers will need to borrow more at lower interest rates.

The interest rate is the rate of return (yield) on financial assets or financial instruments, such as bonds. Therefore in figure 13.3, the demand for funds curve represents the supply of financial assets by lenders. Any factor that affects the supply or demand for funds in the economy will lead to a change in the rate of interest.

In reality, financial markets do not function like product markets for goods and services, and interest rates are not determined by the normal interation of supply and demand forces. The supply of funds (savings) tends to the unresponsive to changes in the interest rate; this means it is very inelastic. And as we shall see in section 13.6 interst rates are indirectly set by the Reserve Bank of Australia.

Financial institutions act as borrowers f funds when they accept savings deposits, as the banks effectively use these funds to make money for themselves by lending these funds on to other borrowers. Therefore,a rate of interest, known as a borrowing rate, is offered on these funds. In addition, financial institutions charge a reate of interest, known as a lending rate, when they make loands to their customers. These institutions are able to make a profit by charging a lending rate that exceeds the borrowing rate. The difference between these two rates is known as the interest rate differential, or the interest rate margin.

We often distinguish between short term and long-term interest rates based on the length to maturity of the financial assts or securities. For instance, when the Commonwealth Government neets to borrow funds. It can use either short-term securities or long term securities. Interest rates on loans with a maturity of less than a year are known as short-term interest rates. Some instruments can have very long term maturities – for example, mortgages for license purchases can be for up to 25 years. The interest rates on longe-term securities are not necessarily the same as interest rates on short term securities. Longer-term securities are often seen as more risky and are also less liquid. A a result the return required for those assts will usually be higher and lenders will receive a higher interest rate.

Any factor that affects the supply or demand of funds in the financial markets will also