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The Business Cycle and Interest Rates

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The Business Cycle and Interest Rates Powered By Docstoc
					Interest Rates and
the Business Cycle
    The Official Cash Rate - OCR

   The OCR is an interest rate set by the
    RBNZ

   The RBNZ can influence interest rates in
    the economy through the OCR
                       The OCR
   How the RBNZ influences interest rates with the
    OCR.

   Banks borrow „overnight cash‟ from the RBNZ.
   The RBNZ charges interest rates 0.25% above the
    OCR for loans

   Banks also deposit cash with the RBNZ.
   The RBNZ pays an interest rate
    0.25% below the OCR for these
    deposits.
                       Example
   The RBNZ announces that the OCR is 2.5%

   What interest rate do banks pay the RBNZ for
    loans?
       Banks pay 2.75% for loans from the RBNZ


   What interest rate does the RBNZ pay banks for
    deposits?
       The RBNZ pays 2.25% for deposits by banks.
                What is the OCR
   The RBNZ uses the OCR to effect interest rates
    thus manipulates the level of Spending,
    Investment, and Net Exports in the economy.

       The C + I + (X – M) component of AD (GDP)

                              Investment




                             OCR effects……

              Net Exports                    Consumption
        How the OCR effects spending (C)

   An increase in the OCR leads to…..
       an increase in interest rates
       it becomes more attractive to save
       less attractive to borrow.
       spending will drop


   A decrease in the OCR leads to…..
       a decrease in interest rates
       it becomes less attractive to save
       cheaper to borrow
       Spending will rise
How the OCR effects Investment (I)
   An increase in the OCR leads to……
       an increase in interest rates
       more expensive to borrow
       Less attractive to invest


   A decrease in the OCR leads to…..
       a decrease in interest rates
       more attractive to invest
       cheaper to borrow
OCR and the exchange rate (X – M)
   When the OCR rises, (overseas) investors will place
    their money in our banks.
        In order for overseas investors to invest their money in NZ
        they must demand the $NZ.
       The $NZ dollar appreciates, which makes exports more
        expensive and imports cheaper.


   When the OCR falls, (overseas) investors will take
    their money out of banks in NZ and invest elsewhere.
       They then sell (supply) the $NZ to buy (demand) another
        currency.
       The $NZ depreciates, which makes exports cheaper and
        imports more expensive.
    What is happening at the moment?
   OCR unchanged at 2.5 percent
   Date 28 April 2011

   The Reserve Bank today left the Official Cash Rate (OCR)
    unchanged at 2.5 percent.

   Reserve Bank Governor Alan Bollard said: “The outlook for the
    New Zealand economy remains very uncertain following
    February‟s Christchurch earthquake.

   “As was expected, business confidence, consumer spending
    and tourism activity all declined sharply following the
    earthquake. The OCR was cut as insurance to help limit these
    adverse effects. Confidence and consumer spending have since
    shown signs of recovery, but many firms and households
    remain adversely affected in Christchurch. To date, activity in
    the rest of the country appears relatively unaffected, with
    housing market turnover and business investment beginning to
    increase.
    What is happening at the moment?
   “Trading partner growth remains robust, helping push New
    Zealand‟s export commodity prices higher. Along with relatively
    favourable climatic conditions, the improved price outlook is
    supporting a pickup in on-farm investment. Higher oil prices
    and the elevated level of the New Zealand dollar are both
    unwelcome. They will have some dampening effect on
    economic activity.

   “Headline inflation is currently being boosted by recent
    increases in indirect taxes. Annual inflation is expected to settle
    comfortably within the target band once these tax increases
    drop out of the annual rate.

   “Given the outlook for core inflation and continued economic
    disruption stemming from the earthquakes, the current level of
    the OCR is likely to remain appropriate for some time.”
      The Business (Trade Cycle

   Over time fluctuations in economic activity
    occur.

   The trade cycle shows us how fluctuations
    in the levels of output, employment,
    income and trade affect the level of real
    GDP.
Real             A Typical Trade Cycle
GDP




              Peak



                     Recession              Recovery


       Boom


                        Trough/Depression

                                                Time
                        Trade Cycles
   Boom
       Rising interest rates
       High eco activity
       “Full” employment
       Great optimism
       Businesses operating at capacity

   Peak (Turning point)
       Eventually rate of growth must slow down. Even if economy is still
        growing it is now doing so at a decreasing rate

   Recession
       Rising unemployment and business failures
       Savings may increase as people fear unemployment
       Business activity slows down
                        Trade Cycle
   Depression (Trough)
       Unemployment stabilised
       Low level eco activity
       Excess capacity
       Interest rates low
       Low consumption , low saving

    Eventually some major piece of capital equipment will need replacing-
      injection of investment lead to recovery
                                                    Start workbook page
   Recovery                                        56 question 6,7 and
       Rise in real GDP slow at first, speeds up   page 58 question 12
       Rehiring of workers as demand increases     and 13
       Unemployment falls
       Consumption increases
            The Business Cycle
A business cycle is identified as a sequence of four
  phases:
     Expansion (A speedup in the pace of economic
      activity=higher GDP)
     Peak (The upper turning of a business cycle)
     Contraction (A slowdown in the pace of economic
      activity=lower GDP)
     Trough (The lower turning point of a business cycle,
      where a contraction turns into an expansion)
   The Economy‟s Sustainable Growth
                Path
Change
     in
Growth
                              This is the
                               economy‟s
                               capacity to supply
                               goods and services
                               over time without
                               the rate of
                               inflation increasing
                               (GDP increases at
                               sustainable rate
                    Time       which matches
                               increase of
                               resources)
                   BA – Positive
                      – Negative  Output
                    Gap. The economy
                   Gap. The economy isis
                    trying to below the
                   producing produce a
                    level of GDP that
                   sustainable level ofis
Change
                    above the sustainable
     in
                    growth path resources
                   output (some of the
Growth
                   are idle). Demand for
                    economy (using
          a         resources less than
                   resources isfasterthan
                    they can therefore
                   the supplyreplenish).
                    Demand for resources
                   general price level will
              b     exceeds supply
                   drop causing
                    therefore price level
                   disinflation or deflation.
                    and inflation will
                    occur.
   A. AD increases        B. AD decreases
    causing inflation       causing disin/deflation
       Governments use of OCR
   The government manipulates the OCR to level out
    the peaks and troughs.

   When in recovery the government will increase
    the OCR (increasing interest rates) to discourage
    excess consumption and investment in order to
    minimise the peak.

   When in recession the government will decrease
    the OCR (decreasing interest rates) to encourage
    consumption and investment in order to minimise
    the trough.

				
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