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Monetary policy refers to actions by the Reserve Bank to influence the aggregate supply and cost of credit in the economy The main tool of monetary policy is the Reserve Banks use of market operations to influence the cash rate or interest rate paid on highly liquid deposits in the cash market or short term money market By influencing the cash rate the Reserve Bank is able to indirectly affect the term structure of interest rates in the financial system which in turn will affect the level of spending inflation and employment in the economy As it is set out in the Reserve Banks mission statement the core objective of monetary policy is to ensure stable economic growth with low inflation that is an underlying rate of between 2 to 3 over the course of the economic cycle and full employment Monetary policy is implemented by the Reserve Bank through the use of open market operations in the short-term money market Through the buying or selling of Commonwealth government securities for example Treasury Notes the Reserve Bank can influence the cash rate which is the interest rate paid on funds lent overnight in the short term money market The cash rate is the principle instrument of monetary policy and if the Reserve Bank wishes to alter the stance of monetary policy it will act to change the cash rate On a daily basis the banks hold funds in their exchange settlement accounts to cover net withdrawals of funds from their banks as cheques clear on a daily basis These are transferred between banks as the exchange settlement process occurs If banks are left with excess funds in these accounts they can lend them to the authorised dealers overnight who typically hold a portfolio of government securities and finance their portfolio by borrowing from banks The interest rate at which these funds clear this market each night is the overnight cash rate
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