Interest Rates, well, it's a very large and complex question you've
levelled there. Unfortunately, I'll only cover the basics.
.
Basically, interest rates are determined by 5 things (in economics):
a) How much people are saving
b) How much firms are willing to borrow
c) The current stance of monetary policy
d) The current stance of fiscal policy
e) All the things the foreigners are doing.
.
Now monetary policy is enacted by changing the rate of return on the
exchange settlement accounts that banks hold with the RBA. Banks then
decide on how much to leave in their accounts, and how much to lend
out. This is an important point, since this mechanism works by a
'liquidity squeeze'. If there is alot of money in the money markets,
it isn't very urgent to cut rates to lend it out. The cost of holding
this money is only the opportunity cost. However, when rates rise and
banks withdraw money from the money markets, this leads to a liquidity
squeeze. The effect is felt immediately, since many firms have cash
flow shortages.
.
Similarly, fiscal policy works by the issue of 'Commonwealth
Government Securities'. These bonds are considered riskless in
Australia, and are therefore used to price other, riskier assets.
Obviously, the price of the bonds is related to the number of bonds on
offer. It is an ordinary supply/demand model with substitutes
available.
.
Similarly, the level of economic activity is important. The more
people save, the more funds available for lending (Supply of lending
money increases, interest rate driven down). But the more people save,
the less they spend, and so there are fewer investment opportunities,
an a fall in investment (demand for credit falls, interest rate driven
up).
And finally, the story on the rest of the world. Foreign interest
rates influence domestic interest rates and exchange rates. Foreign
economic activity affects the local economy through exchange rate,
import and export mechanisms.
It is important to note that the RBA advises that monetary policy can
take 12-18 months to take effect (presumably increases are towards the
12, decreases towards the 18).
As you can see, these factors are quite complex If I were to estimate
a regression equation, I would be using a log-log model,
autocorrelation, lagged variables using investment, savings and money
supply, and it wouldn't surprise me if you have to make a
differenced-log model. BTW, don't try ARIMA modelling, it's quite poor
for interest rate forecasting.
In terms of contemporary economics (rather than theory), it's unlikely
that the RBA will increase rates. The housing market is booming right
now, but is booming only temporarily, driven by a huge demand shock
induced by the Howard governments first home buyers grant. After the
inital shock finishes, construction will be moving ahead, but not as
quickly. This won't affect the rest of the economy.
It's important to realise that monetary policy is a 'blunt'
instrument, unlike taxation and spending. MP hits the whole economy,
and with only one sector booming excessively (housing) and a
relatively slow global economy, it's highly unlikely that the rates
will rise in the near future. |
