Summary
A policy is typically a rule or a decision that is meant to guide decision making for the purposes of achieving outcomes that are rational. Policies can fall into several different categories and therefore, can be understood as financial, political, management, as well as administrative mechanisms or methods that are have been arranged and put in place so as an organization can obtain explicit goals. (Althaus, Bridgman, and Davis, 2007).Policies can result to impacts and effects that are both intended and unintended. The intended impacts of a policy depend on the organization and the context under which these policies were drawn. Generally, policies are an organization’s response to undesirable negative effects that have already been identified. In most cases such policies bring about tremendous benefits to the organization. However, it is also common to come across policies with undesirable impacts on an organization; or to find a policy that has brought about unintended effects in an organization (Althaus, Bridgman, and Davis, 2007). For example, there have been two main government policies in Australia that have had a lot of influence on the loanable funds market. These policies are the established trade policies and the interest rates policies. These two policies are related in some, especially when it comes to how they affect the supply and demand curves of the loanable funds market in both the Australian economy and the global economy.
The purpose of this paper therefore, is to look at some of the impacts, both negative and positive; these Australian government policies have had on the market for loanable funds in the country. The two policies of interest in this paper are going to be; one, the decision by the RBA to maintain the cash rate interest at 4.75 percent, after it increased since last year from 4.5 percent. The second policy the paper is going to focus on is the current Australian trade policy.
The RBA’s Decision to Maintain the Interest Rate at 4.75 Percent
During its board meeting held on 5th April this year, the Reserve Bank of Australia made a decision to keep the official interest rates at 4.75 percent. This decision to hold the interest rates stable met the expectations the financial markets had (Olsen). The reason to maintain the interest rates at this rate was probably influenced by the current global economy financial conditions that have so far remained accommodative, by the terms of trade in Australia that have reached the highest level, despite the continued saving by the household sector, the overall growth in the country that has remained low, the slow or moderate growth in employment and the steady unemployment rate being witnessed in the country; plus the consistent inflation in Australia that has remained within the range of 2 and 3 percent. As a result of such conditions, the bank’s board felt that it was proper that the monetary policy stayed appropriate, given the current general outlook of the country’s macro economy. The market therefore, is predicting that there will likely be no official change in interest rates in the next few months, because the country is still trying to battle the effects its two speed growth in economy is having on its markets. An example of this effect is the boom of the powerful resources, which are being offset by the challenges the retail markets are emitting (‘Interest rate updates’).
This decision by the banks to keep the interest rates at the same level can have tremendous effects on the market of loanable funds. The term loanable funds can be used to define the funds in a country that are available for the citizens to borrow. These kinds of funds include bank loans as well as household savings. Due to the fact that new capital investment is commonly made using loanable funds, a country’s capital demand and supply is usually discussed in terms of the loanable funds’ supply and demand. It is in the loanable funds market where lenders and borrowers meet. In other kinds of markets, a demand curve as well as a supply curve is always present. In contrast, the framework of loanable funds markets is one whereby supply reflects the total amount of funds being given out as loans at interest rates that are different, or the total amount the economy is saving. The demand curve on the other hand shows a country’s borrowing total demand at any stated interest rate (‘Capital, loanable funds, interest rates’).
Lending and borrowing under this market takes many forms. When a person saves a part of their income in the bank, that saved income immediately becomes available as a loanable fund for someone else. This is because all the money that has been saved in the banks is part of the loanable funds supply. Therefore, when one deposits money in the bank, he becomes a supplier of funds being used in the framework of the loanable funds (Mankiw, 2004). For example, if an individual earns an income of 20 thousand dollars, and he spends 18 thousand dollars of that money on goods and services, and saves the remaining 2 thousand dollars in the account, then the loanable funds supply will have increased by a total of 2000 dollars. This will increase demand because another person, a borrower, will have these 2000 dollars available to them for borrowing. Interest rates influence greatly the amount of loanable funds. For example, the quantity available in the banks as loanable funds increases with the increase in interest rates. This is because an individual mostly looks at the numerous advantages they can benefit from when they save when deciding on the amount of money to save. With the increase in interest rates then, the benefits one gets from saving also increases, and this usually motivates many people to save more. Generally, the quantity of loanable funds supplied increases with an increase in interest rates. On the other hand, the demand for these loanable funds usually decreases with an increase in interest rates. This is because a borrower always anticipates the cost of borrowing to increase with an increase in interest rates (Mankiw, 2004).
With such expectations and perceptions, such individuals are less likely to borrow from the loanable funds. The demand curves usually slopes down with an increase in interest rates, while the supply curve usually slopes up ward. What then happens when the interest rates remain at the same level? With the decision of the RAB to maintain the interest rate at 4.75 percent, it is likely that demand for loanable funds will keep on increasing because the interest rates are still too low. This will discourage saving because of the low return saving earns. Because of the huge attraction of borrowers, a lot of borrowing will ensue and as a result the interest rate will rise to equilibrium as borrowers continue to compete for the favorable loanable funds. On the other hand the country could experience a trade deficit because of the resulting low saving rate, something that results to low capital available for consumption that comes along as a result of low rates of saving (Mankiw, 2004). Below is a figure showing the loanable funds framework (‘Chapter 3’);
Trade Policy and its Impact on Loanable Funds Market
Australia has established, and maintains, a diverse and an active agenda on international trade policies that involves the use of multilateral, bilateral and regional strategies to break down various barriers to trade in the world, and in so doing gain new opportunities through acquiring of new markets, as well as maintain its competitiveness in exports. The trade policies of the country are therefore, based on the reforms in the structure of the country’s economy, for the purposes of enhancing its competitiveness in international trade, and initiatives to increase the liberalization of investment rules and international trade (‘International trade policies- free trade agreements’). As a result of this, Australia generates more than 20 percent of its national income from foreign trade, and also benefits from more than two million jobs the industry offers. Each day the country exports such goods as farm products, fuel, minerals, medicine, and cars to more than 200 countries all over the world. Imports are important to the country’s open economy as well (‘Trade at a glance 2010’).
An open economy such as the one that has been created by the Australian trade policy can have many effects. It can produce such impacts from two main assumptions usually common in this kind of market. One is that spending must not always be equal to output, the second assumption is that saving does not have to be equal to investments. As a result of these assumptions, a country can spend more than its output, simply because of the possibility of or option that it can import goods. This can in turn lead to the country spending less and less of its outputs, and therefore, exporting most of its outputs. Just the same, a country with an open economy like Australia has an opening to save abroad through the buying of foreign assets, and a similar opening to borrow more than the country is willing to lend abroad, by selling bonds to foreign markets (Mankiw).
This increased saving causes an increase in the net capital flow. Unlike a closed economy, an open economy’s investments are not limited or constrained by domestic or fixed loanable funds supply. The world’s interest rate is also another variable affected by the open economy trade policy. This is because the interest rate depends on a country’s investment and saving in the world’s loanable funds. If the world interest rate increases therefore, a country’s open economy investment is reduced, and this generally leads to the reduction in the demand for loanable funds; because the supply of the funds remains constant the amount of funds flowing abroad increases (Makin, 2004). As a result then, the increase in the demand of loanable funds by an organization can be satisfied and met by the foreign markets from which the organization borrows from abroad though the sale of bonds. This results to a decrease in the net outflow of a country’s financial capital. Below is a diagram that shows the effects of an increase in investment demand; NX is size of trade surplus, I, is interest, and S is total of a country’s saving (Mankiw);
Effects of the Two Policies
Both these two policies will have an effect on the rate of public saving. The interest rate policy will have this effect through decreasing the bank’s interest rates, and therefore, through increasing the demand for loans and reducing their supply. The trade policy on the other hand will have this effect through allowing the Australian government to spend more leading to an increase in the budget deficit. National saving is the same as the amount of savings that go into a country (Makin, 2004). National saving therefore includes all the private saving that occurs when people save more than they consume, and the public saving that takes place when a government spends less than the amount of revenue it collects. As a result of decreased public saving, which results from these two policies, the interest rates will be forced to increase because of the decrease in the supply of loanable funds. Generally, these two policies will lead to higher interest rates, which will ultimately discourage borrowing from the private sector. These increased interest rates will also crowd out most of capital investments held privately (Mankiw).
Arguments and Supporting Results
Generally, these two policies have a lot to do with the Australia’s interest rates. It is important to note that interest rates are mainly determined by the interaction that exists between supply and demand of loanable funds. Therefore, an increase in demand in loanable funds will result to an increase in both the level of borrowing and lending, and interest rates. A decrease in demand on the other hand will have the opposite effects. An increase in supply will lead to an increase in the level of borrowing and lending, and a decrease in the interest rates of the loanable funds.
Decreases in supply will however, result to a decrease in lending and borrowing and an increase in interest rates (Mankiw). For example, let us say one has an extra 5000 dollars in their checking account, and the banks interest rates are as low as 1 percent. The only money that individual can earn from saving is 50 dollars in a year. Such an individual can decide to use the money in other activities like buying a computer instead of having it earn little interest. Another person, might however, be a member o another bank offering up to 15 percent in interest. If one saves this money for a year, they can get an extra 750 dollars. This individual is more likely to save than the other person having an interest rate of 1%
Conclusion
The loanable funds market can be affected by many aspects in a country’s economy. Some of the most important influences of this market are the policies that most governments establish to govern trade and other business factors in a country. These policies, as we have seen above, can have both positive and negative impacts on the loanable funds market. For example, because of the two policies the paper has discussed it would be correct to conclude that the Australian loanable funds market would experience certain changes in regards to the level of saving. Because of the low interest rates created by both low demands (constant interest rate policy), and increased government spending (trade policy), the Australian market for loanable funds will experience an increase in interest rates. This will in turn to a decrease in the supply of the loanable funds and an overall decrease in private borrowing. The market will also experience a crowding out of some of the capital investments held privately.
References
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