Question

Suppose RBA decides to reduce the cash rate to 0. What do you think will be the effect on AUD? Use UIP to explain the effect

Answer 1

When cash rates are decreased by RBA, the interest rates move un tandem and thus decline which stimulates households spending and consumption. However as drawback it leads to lower returns on investment for foreign investors and thus they park their money into nations with higher interest rates comparatively causing outward flow of AUD which leads to depreciation or devaluation of AUD due to uncovered interest rate parity or the interest rate difference between nations.

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