Reference no: EM133131932

Consider the following transactions:

1. Top Bank repays a $40m interbank loan from Bottom Bank.

2. Middle Bank pays a $1m fine to the RBA, the Australian central bank, for not meeting reserve requirement.

3. Bottom Bank pays $0.5m interest on its RBA lending facility loan.

4. Top Bank pays $20m on the government's account at the RBA for the purchase of government bonds newly issued.

5. The RBA pays $3m salaries to its employees, who have a bank account at Middle Bank.

a. (i) Show how the balance sheet of the RBA is affected by these transactions. Represent all transactions in the same balance sheet and indicate for each transaction the item number as shown in the list.

a. (ii) Calculate the overall net impact of these transactions on the supply of Exchange Settlement Funds (ESF) in the banking system.

b. (i) Show in a detailed and well labelled diagram of market for reserves the effect on the equilibrium cash rate of the change in ESF described in a (ii) , combined with a decrease in the demand for reserves by $5m. Assume the market for reserves was originally at equilibrium at the current cash rate target of 0.10%.

b. (ii) Explain in words the mechanisms that led the adjusment from the original equilibrium to the new equilibrium.

c. (i) Using a different colour, represent the action of the RBA on the diagram in b(i) as part of its cash rate targeting policy at 0.10%.

c. (ii) Describe with details the transactions that the RBA is likely to have done to reach the outcome described in c (i).