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Study Guide
1203AFE Money Banking and Finance
(INSTRUCTOR’S VERSION)
TOPICS 1-3

About this guide

This guide contains relevant study information for each topic covered in this course. For each
topic the relevant chapter materials are noted as well as a three different types of questions ordered
by learning objective References refer to the question numbering in the text (if relevant).

Review Questions:
The review questions will be introduced in the lecture and you should attempt to develop a
full answer to these questions prior to attendance at the tutorial that covers that topic.
These questions will not be discussed in tutorials in any depth unless you raise any
difficulties with them at the start of the relevant tutorial.

Discussion and Presentation Questions:

These questions will be worked through in small groups with a facilitating full class
discussion in the tutorials. You should be prepared for this discussion by reviewing the
reading materials for that topic prior to attendance at the tutorial. These questions are those
that students will be allocated to present in the tutorials as part of the formal assessment for
the course. For your assigned topic you are required to prepare and present a full answer to
this as per the assessment guidelines. For other questions you should prepare by reviewing
the reading materials for that topic prior to attendance at the tutorial.

Each week you should compile detailed answers to these questions. In doing so you should
develop an understanding of the concepts and information contained within them. Any unresolved
questions should be dealt with by further review of the reading materials, consulting with your
peers and/or by discussion with the teaching team during consultation hours. This is a critical
process to succeeding in the course and will form the foundation of your study and review
materials for the exam and quiz assessment items.

Throughout the semester example answers and notes for these questions may be placed on the
course website by the teaching team. These are not intended to be complete (model) answers, but
to assist students in their study and should be supplemented with further notes, examples, data etc.

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Topic 1 - Introduction
Learning Materials: Kidwell et al text, 3e, Chapter 1

LO1: Explain the role of the financial system and why it is important (p4-14)

Review Question
1.1 Describe how financial markets facilitate the flow of funds.
 Financial institutions allow flow of funds from savers to borrowers
 Savers give funds to financial markets in hopes of making a profit

Discussion and Presentation Question

1.2 Explain the key roles of the financial system. Why is it so important to the broader economy to
have an efficient and effective financial system? (ECQ 1.1)
Financial markets are the markets for buying and selling financial instruments. Financial markets have five
primary functions:
1. facilitating the flow of funds
2. providing the mechanism for the settlement of transactions
3. generating and disseminating information that assists decision making
4. providing means for the transfer and management of risk
5. providing ways of dealing with the incentive problems that arise in financial contracting
Having an efficient and effective financial system is critical as it facilitates commercial, retail and
government transactions in a timely, low cost and reliable way. The opposite would be a system where
funds take a long time to reach their destination (i.e. direct debits may take weeks), with high cost
(significantly greater transactions costs) and with great risk (to either their value or likelihood of arrival).
An efficient and effective financial system will also produce actual and timely information to enable
effective financial decision making, which is also important in the complex financial world of today.
When one considers what we take for granted in the financial system (EFTPOS, Electronic Transfer,
Direct Debit, etc. in terms of its reliability) and consider the time and cost involved in doing this manually,
one can see the importance of the financial system.

LO2: Explain the function of direct and indirect financial markets (p14-20)
Review Question:
1.3 What is the difference between direct and indirect financial markets?
In direct financing, DSUs and SSUs exchange money and financial claims directly. DSUs issue financial
claims on themselves and sell them directly to SSUs for money. The claims issued by the DSU are called
direct claims and are typically sold in direct credit markets, such as money or capital markets. Investment
bankers can help DSUs market newly created financial claims, or the corporation can sell a financial claim
directly to investors via a private placement.
In contrast, indirect financing involves financial intermediaries (commercial banks, credit unions,
life insurance companies, superannuation funds etc) who transform financial claims in ways that make
them more attractive to the ultimate investor. Financial intermediaries purchase direct claims (IOUs) with
one set of characteristics (e.g. term to maturity, denomination) from DSUs and transform them into
indirect claims (IOUs) with a different set of characteristics, which they sell to the SSU. This is called
financial intermediation.

Discussion and Presentation Question(s):

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1.4 Explain the concept of financial intermediation. How does the possibility of financial
intermediation increase the efficiency of the financial system? (ECQ 1.10)
Financial intermediation is the process by which financial institutions mediate unmatched preferences of
ultimate borrowers (DSUs) and ultimate lenders (SSUs). Financial intermediaries buy financial claims with
one set of characteristics from DSUs, and then issue their own liabilities with different characteristics to
SSUs. Thus, financial intermediaries “transform” claims to make them more attractive to both DSUs and
SSUs. When intermediaries transform direct claims into indirect ones, they perform five services:
– Denomination divisibility
– Currency transformation
– Maturity flexibility
– Credit risk diversification
– Liquidity
This increases the amount and regularity of participation in the financial system, thus promoting the 3
forms of efficiency—allocational, informational, and operational.

1.5 What is a financial claim? How can a financial claim be both an asset and a liability at the same
time? (LCQ 1.2)
A financial claim (or “security” or “financial instrument”) is one’s claim against another’s wealth. To its
holder, it is a financial asset; to its issuer, a liability or obligation. It may be debt (contractually promising
repayment with interest on a certain schedule) or equity (part ownership rewarded by participation in
profits). DSUs issue claims in return for funds; SSUs exchange funds for claims.

LO3: Describe the different types of financial institutions (p20-27)

Review Question:
1.6 Describe the many types of financial intermediaries that exist in the Australian economy.
Many types of financial intermediaries coexist in our economy. Though different, financial intermediaries
all have one function in common: they purchase financial claims with one set of characteristics from DSUs
and sell financial claims with different characteristics to SSUs. The Australian system consists of the RBA
and many private institutions. Of the private institutions, commercial banks are the largest, with nonbank
financial institutions and a variety of financial intermediaries including superannuation funds, managed
funds, and insurance companies making up the sector. Other groups of organizations within the sector
include those that are more service businesses that advise on financial products. This group includes
financial advisors and planners as well as research and data organizations.

Discussion and Presentation Question(s):

1.7 Examine the data in table 1.2 and discuss the impact that the GFC has had on the different types
of financial institutions. (ECQ 1.12)
Table 1.2 shows that over the crisis period (2007-2009), the banks came out on top with an increase in
growth in assets over the period of approx 23%. Conversely, securitisers’ assets declined by approx -29%,
public unit trusts -16% and superannuation funds -5%, reflecting the impact of stock market declines on
the superannuation and unit trusts. In the case of securitisers, their performance relates to the lack of
appetite for mortgage backed securities as well as a decline in the value of the underlying assets held in
existing portfolios (the decrease in property values and increasing numbers of loan defaults). Despite this,
the Australian financial system has been comparatively very robust and had no direct cash bailouts such as
those that occurred in most other developed countries. The reasons for this are discussed in the
Since the 2008 GFC, Table 1.2 shows a steady decline of assets from 2009-2011 in money market
corporations, finance companies, public unit trusts, cash management trusts, common funds, friendly

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societies, and securitisers. Table 1.2 shows growth in assets in banks, building societies, credit unions, life
insurance offices, superannuation funds, and general insurance offices.

In Focus below.
Overall, the financial intermediaries’ assets grew at an annual average rate which was higher than the rate
of growth in the economy as a whole, which grew at approximately 4 per cent annually, and reflects the
growth in indirect securities issued, the increase in the proportion of funds being channeled through the
intermediation market and the tremendous wealth created by the Australian economy in recent years.
Since the 2008 GFC, the sectors which have grown are those which manage savings such as banks,
superannuation and life insurance firms.

Over the full period of the data set in the table, the fastest growing groups of financial institutions are the
securitisers at 21% growth. They are followed by public unit trusts (14%) and superannuation funds (13%).
Interestingly, these groups made significant gains in the period leading up to the crisis (2000-2006) with
22%, 14% and 16% growth respectively. However, when one examines the crisis period many of these
trends reverse with the Banks by far the best performers and credit unions and finance companies the
only other classes of institution increasing its assets (and at significantly less a rate than the banks). The
star performers – the securitisers fell 25% from 2007-2009 as mortgage backed securities fell out of favour.
Overall, banking assets in Australia are spread across a variety of different types of institutions
including banks, credit unions, building societies and other financial institutions. While there are more
credit unions than any other type of institution, the banks dominate the percentage of assets held and
within this the four big banks hold the clear majority and dominate the entire sector. Indeed, these four
institutions dominate much of our region with significant control over New Zealand and the Pacific Island
countries.

LO4: Describe the various types of financial markets (p27-29)

Review Question:
1.8 What is the difference between primary and secondary markets?
Primary markets are those in which financial claims are initially sold by DSUs. All financial claims have
primary markets. Secondary financial markets are like used-car markets; they let people exchange ‘used’
or previously issued financial claims for cash at will, and hence they provide liquidity for investors who
own primary claims. Securities can only be sold once in a primary market; all subsequent transactions take
place in secondary markets. The Australian Securities Exchange (ASX) is an example of a well-known
secondary market.

LO5 and LO6: Explain the economic function of money and capital markets (p29-31)

Review Question:
1.9 Explain why the money market is so important in our economy today
The money market is important because it is the world's most liquid market. It is the market in which the
central banks conduct monetary policy and the government finances most of its credit needs in the money
market. Furthermore, in the money markets, businesses, governments, and, sometimes, individuals
borrow or lend funds for short times: usually from one to 120 days .

Discussion and Presentation Question:

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1.10 Explain the difference between money and capital markets. Which market would Holden (GM)
use to finance a new vehicle assembly plant? Why? (ECQ 1.13)
Money markets are markets for liquidity, whether borrowed to finance current operations or lent to avoid
holding idle cash in the short term. Money markets tend to be wholesale OTC markets made by dealers.
Capital markets are where real assets or “capital goods” are permanently financed, and involve a variety of
wholesale and retail arrangements, both on organised exchanges and in OTC markets. GM would finance
its new plant by issuing bonds or stock in the capital market. Investors would purchase those securities to
build wealth over the long term, not to store liquidity. GMAC, the finance company subsidiary of GM,
would finance its loan receivables both in the money market (commercial paper) and in the capital market
(notes and bonds). GM would use the money market to “store” cash in money market securities, which
are generally, safe, liquid, and short-term.

LO7: Identify the risks that financial institutions face and describe how these risks are managed
(p38-42)
Review Question:
1.11 Does managing risk mean that risks are eliminated? What is the trade-off?
Managing the plethora of risks that financial institutions face does not mean that they can be entirely
eliminated. There is a trade-off between risk and higher profits. Managers who take too few risks may face
backlash from shareholders when earnings decline and stock prices fall. On the other hand, excessive risk-
taking also makes shareholders and other stakeholders unhappy, as it puts their investment at risk,
especially if losses are great. Each risk must be managed carefully to balance the trade-off between future
profitability and potential failure.

Discussion and Presentation Question:

1.12 What are the major risks faced by financial institutions and why is it important that each is
carefully managed? (ECQ 1.18)
Credit Risk (or default risk) is the possibility that a borrower may not pay as agreed. Management of
credit risk is important as excessive credit risk will lead to higher regulatory costs (credit based capital
adequacy requirements to be discussed later in the text) and may lead to the failure of the firm through
cash flow and non-performing loans problems.
Interest Rate Risk is the likelihood that interest rate fluctuations will change a security’s price and
reinvestment income. As a significant part of financial institutions investments and sources of funds are
interest-bearing and profits are generated on the margin between these, managing both the investment
and funding portfolio’s for interest rate risk is important for profits, cash flows and the stability of the
institution.
Liquidity Risk is the possibility that a financial institution may be unable to pay required cash outflows. If
a financial institution is unable to meet its short-term obligations because of inadequate liquidity, the firm
will fail even though over the long run the firm may be profitable.
Foreign Exchange Risk is the possibility of loss on fluctuations in exchange rates. These fluctuations can
cause gains or losses in the currency positions of financial institutions, and they cause the Australian dollar
values of non-Australian financial investments to change.
Political Risk is the possibility that government action will harm an institution’s interests. This includes
changes in regulation, appropriation of assets, changes to foreign investment and currency transfer and
trading rules, all of which can influence the earnings and value of a financial institution.
Reputational Risk is the potential for negative publicity to cause loss through decline in customer base,
increased litigation and revenue reductions.
Environmental Risk is the actual and/or potential threat of adverse impact on asset values due to changes
in the environment and/or organisational impacts on the environment.

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Operational Risk is the actual and/or potential risk of loss form the execution of a company’s business.

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Topic 2- Monetary Authorities

Learning Materials: Kidwell et al text, 3e, Chapter 2

L01: Describe the origins of the central banking system model (p66-68)
Review Question
2.1 What is the role of central banking authorities today?
A central bank regulates a nation’s money supply and financial institutions in an attempt to provide the
nation with a stable economic environment and effective payments system.

Discussion and Presentation Question

2.2 What are the major regulatory bodies in the Australian financial system and what are their main
roles?
In Australia these bodies are:
 The RBA, Australia’s central bank, is responsible for monetary policy, systemic stability and the
payments system.
 APRA is responsible for prudential supervision of financial institutions including banks, credit
unions, building societies, and insurance and superannuation companies.
 ASIC is responsible for enforcement of company and financial services laws, with the aim of
protecting consumers, investors and creditors. This includes the responsibility for licensing and
monitoring financial markets and advisors, and monitoring the disclosure and conduct of
Australian companies and financial services providers.
The three agencies are coordinated by the Council for Financial Regulators (CFR), which acts as a
mechanism for sharing information on views and discussion on regulatory issues between the three
agencies.

LO2: Explain the RBA’s primary responsibilities as a central bank (p68-82)

Review Question
2.3 What is the RBA’s Charter, and what are there any conflicts between its goals?
The Reserve Bank Act section 10(2) states that-
It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and
banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the
powers of the Bank…are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best
contribute to:
a. the stability of the current of Australia;
b. the maintenance of full employment in Australia; and
c. the economic prosperity and welfare of the people of Australia.
While objective c. is vague, objective a. seems to conflict with objective b. as maintaining low inflation
often involves actions that may harm employment, such as increasing interest rates. Consequently, the
RBA needs to prioritize its goals, and has adopted maintaining low inflation as its primary objective.

Discussion and Presentation Questions

2.4 Outline the key functions and responsibilities of the RBA.
The primary functions of the RBA are:
 the determination and implementation of monetary policy
 issuing Australian currency notes
 overseeing the payments system and facilitating its operation
 acting as the government’s banker and issuing securities on its behalf

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 issuing and providing the market for Commonwealth treasury securities

 managing financial system liquidity and the government’s holding of foreign exchange.
The primary statutory responsibilities of the RBA are now embodied in the Reserve Bank Act section 10(2)
and are often referred to as the RBA’s charter:
It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the
monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia
and that the powers of the Bank… are exercised in such a manner as, in the opinion of the Reserve Bank
Board, will best contribute to:
 the stability of the currency of Australia;
 the maintenance of full employment in Australia; and
 the economic prosperity and welfare of the people of Australia

2.5 Explain the sense in which the RBA is independent of the Federal Government. How
independent is the RBA in reality? What is your opinion about the importance of the RBA’s
independence for the Australian economy?
The term ‘RBA independence’ means that the RBA is free from political and bureaucratic pressures when it
formulates and executes monetary policy. The RBA is not directly under the authority of the Government
or the Prime Minster. Whether independence is important is a debated issue. Advocates of independent
central banks believe that independence from day-to-day political pressure allows central banks to better
manage their countries’ national economies. By ‘better’ we mean that the central bank can take short-run
policy actions that may be politically unpopular but in the longer run benefit the economy’s overall
macroeconomic performance. For example, this is often the case when inflationary pressures begin to
build up in an economy during a period of rapid economic expansion. To dampen inflation, a central bank
will raise interest rates to slow the rate of economic growth and thus dampen inflationary expectations.
Needless to say, raising interest rates to slow down an economy rarely wins political applause.
In the short run, the RBA has a relatively high degree of independence because it operates as a
bank and does not rely on the Government for funding. In addition the long, up to 7-year, terms of the
governors, which insulate them from day-to-day political pressures. Assuming no resignations, an
incoming government may have little control over the composition of the RBA Boards.
Over the longer run, the RBA’s independence is constrained with the RBA being fully aware that
Parliament created the Central Banking System and that its charter can always be modified by Parliament.
Also, the RBA in practice is obliged to consult with the Federal Treasury and the Treasurer in relation to
monetary policy. Finally, the RBA is subject to the laws of Australia, which come close to spelling out the
economic responsibilities of the federal government. As a result, the RBA is keenly aware of political
pressures and of secular changes in economic policy.

2.6 Identify the various retail and wholesale payment instruments used in the Australian payments
system.
Payment instruments can be divided into cash and non-cash types. Cash, or legal tender, is notes and
coins issued by the government and represent a store of value. While cash transactions represent a large
percentage of total transactions, given that most of these are small in value, it represents only a fraction of
the value of all transactions in the payments system.
Non-cash instruments can be further divided into paper and non-paper instruments. The most
important low value paper non-cash payment instrument is cheques. Non-paper low value electronic
instruments include EFTPOS, credit cards and direct entry credits and debits.
In addition to the cash/non-cash distinction, the RBA also divides payments into low value
payments (high volume cash and non-cash payments that involve small transfers of value such as cash,
EFTPOS, credit card transactions) and high value payments. High-value transactions are far fewer in

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number, but account for a majority of the value that is settled in the payments system. Common forms of
high value payment instruments are bank cheques and warrants.

LO3: Explain the role of prudential regulation and how the Australian Prudential Regulation
carries out its role (p82-86)
Review Question
2.7 What is prudential supervision, and who is the Australian Prudential Regulation Authority
responsible for supervising?
Prudential supervision of financial institutions is about controlling risk management of financial
institutions, maintain safeness of depositors' funds and provide stability in the financial system. APRA is
responsible for the supervision of banks, insurance and superannuation companies. Specific functions
include:
 The development and implementation of prudential regulation that supervised entities will have
to abide by
 Monitoring regulated entities to ensure they are complying with relevant legislation and
prudential policies
 Advising the government on the development of regulation and legislation affecting regulated
institutions and the financial markets in which they operate.

Discussion and Presentation Question

2.8 Explain why the prudential, risk-based regulation system was adopted in the 1980s and 1990s.
Prudential supervision is about controlling the risk taking of financial institutions. This risk management-
based approach to supervision of financial institutions developed in the 1980s because it was recognised
that the existing bank regulations were reducing competition within the sector. In response, the regulators
liberalised the banking system to allow price competition among institutions by, for example, removing
interest rate controls. This expanded the market for both commercial and consumer loans, because clients
that were previously deemed too high a risk could now be considered with higher interest rates applying
to cover the higher risk. As a result, banks also became exposed to higher levels of risk, particularly given
that they now had to compete for lending business. A strong financial system will also help minimise this
risk.

LO4: Explain the role and responsibilities of ASIC and how it cooperates with other regulators
(p87-89)
Review Question
2.9 Outline the broad responsibilities of ASIC in the regulation of the financial markets
ASIC is charges with the responsibility for enforcing company and financial services laws to protect
consumers, investors and creditors. ASIC’s specific responsibilities are:
 Maintain, facilitate and improve the performance of the financial system and entities within it
 Promote confident and informed participation by investors and consumers in the financial system
 Administer the law effectively with minimal procedural requirements

LO5: Explain the role of the Bank of International Settlements (p89-91)

Review Question
2.10 Discuss the importance of the role of the BIS.
The Bank of International Settlements is an international monetary authority that influences the global
financial system, and plays a crucial role in supporting various central banks and their currencies through a

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variety of crises. The BIS has also been at the forefront of regulatory supervision. It is based in Basel,
Switzerland.
The BIS plays a crucial role in the ever more global financial system, supporting various central
banks and their currencies through a variety of crises, such as in Mexico in 1982 when heavy debt
effectively bankrupted the country. The bank has also been at the forefront of regulatory supervision, with
the widely adopted 1998 Basel Accord on credit risk management and Basel II which expands coverage of
the system to other operational and market risks.

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Topic 3- Monetary Policy

Learning Materials: Kidwell et al text, 3e, Chapter 3

LO1: Explain how the RBA measures the money supply (p101-107)
Review Question
3.1 Why does the RBA measure the money supply?
One of the most important powers of the RBA is its ability to control liquidity in the financial system.
Control of liquidity is exerted through management of exchange settlement funds (ESF) held by financial
institutions at the RBA in exchange settlement accounts (ESA). ESFs are the funds used to settle obligations
among the financial institutions and between the institutions and the RBA. By controlling ESFs, the RBA is
able to control the money supply. Thus, it must measure the amount of money in circulation in order to
know what action to apply to ESFs. The RBA uses its power over ESFs to control the amount of money
circulating in the country.

Discussion and Presentation Question

3.2 Why are there so many measures of money?
Each measure has a different purpose and measures (slightly or largely) different concepts.

LO2: Explain how the RBA influences the level of interest rates in the economy (p107-113)
Review Question
3.3 Explain how the RBA influences the cash rate?
The RBA does not determine the cash rate in a direct regulatory sense. The cash rate is a market-
determined rate negotiated between borrowers and lenders in the overnight bank market in which banks
lend overnight funds to one another. Through open-market operations, the RBA is able to expand or
contract the total reserves in the banking system, which, in the short term, have an impact on the cash
rate and other interest rates in the economy. However, on any given day, many factors affect interest rates.

Discussion and Presentation Question

3.4 Why do the financial markets pay so much attention to the cash rate?
Financial markets pay close attention to the cash rate as it has significant influence on all other interest
rates in the economy. As it sets the overnight cost of funds in the short-term money markets, it has a
direct impact on the rates at which financial institutions borrow and lend at to both retail and business
clients. This therefore impacts on the profitability of existing products (unless rates are/can be moved
accordingly) and drives the cost of capital for individuals (the amount we pay for access to funds through
loans, credit cards etc) and for business. It is therefore a critical economic indicator for the economy and
any moves by the central bank and other participants that result in pressures on the cash rate are closely
observed by all market participants.

3.5 What is likely to happen to the monetary base when (a) Centrelink credits age pensions to
pensioners’ bank accounts, (b) the RBA buys government securities from Australian investors; and (c)
banks raise funds by an overseas note issue?

a – The money supply will increase as any injection of funds by the government to any of the economic
units does this.
b – Increase the money supply as the investors that hold these securities will receive cash for the
securities upon selling them to the government.

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c – No impact as the amount of Australian dollars on issue (and therefore the money supply) does not
change (assuming the government is not a party to the notes issue).

LO3: Discuss the objectives of the RBA in conducting monetary policy (p113-118)
Review Question
3.6 What are the objectives of monetary policy?
The objectives of monetary policy are to maintain the stability of the country’s currency, full employment
and the economic prosperity and welfare of the people.
It also has responsibility for the stability of the financial system. Any disruptions in the financial
system can inhibit the ability of financial markets to channel funds efficiently between surplus spending
units and deficit spending units. Any reduction in the flow of funds will reduce consumer spending and
business investment, which will lead to slower economic growth. Individuals may find it more difficult or
expensive to borrow for transaction purposes.

Discussion and Presentation Question

3.7 Why is rampant inflation considered ‘a bad thing’ for an economy when obviously house prices
rise and home owners receive windfall gains?
Rampant inflation severely affects the distribution of welfare and wealth within an economy. Physical asset
holders and the indebted are favoured; debt holders are punished. Workers with market power are
favoured; fixed-income recipients are punished.

3.8 The more goals you have, the less likely you will achieve all to the same degree. Which goals do
you think are the most important for the RBA to achieve? Why?
Inflation control and steady economic growth. Some under-employment of resources is often inevitable
and can stem from factors other than monetary policy.

LO4: Explain how the RBA’s policies are transmitted through the economy and affect economic
activity (p118-125)
Review Question
3.9 Name and describe the three basic expenditure channels that monetary policy affects.
The three channels are business investment, consumer spending and net exports. Businesses spend on
investment in plant, equipment, new buildings and inventory accumulation. Consumer spending is
typically divided into two categories: firstly, on durable goods such as automobiles, boats, appliances and
electronic equipment and, secondly, on housing, which tends to be very sensitive to interest rates. Net
exports are the difference between goods and services exported into the country and those imported.
Clearly, exports and imports will be sensitive to the exchange rate between the dollar and the currencies
of foreign imports.

Discussion and Presentation Question

3.10 Describe the likely consequences for GDP growth when the RBA sells CGS to raise funds for the
Commonwealth Government?
When the RBA sells CGS to raise funds, this reduces the money supply as investors in the issue use their
surplus funds in the purchase. This serves to put upward pressure on the cash rate which in turn makes
the cost of capital (cost of borrowing funds for all economic units) more expensive. This acts to constrict

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economic activity as a higher cost of funds will place downward pressure on business and consumer
spending and investment as a greater percentage of their existing funds are needed to cover current
variable rate debt. This also makes all new borrowings more expensive, which also reduces expenditure.

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