Q1) What is the difference between the official interest rate and the market interest rate? Explain the mechanism by which the RBA increases the cash rate. Use appropriate diagrams if necessary. The official interest rate is the interest rate set by the central bank for financial institutions. This rate is adjusted by the central bank via foreign exchange settlement accounts. The official cash rate is influenced by transactions between the central bank and financial institutions, as these transactions change the money supply. If financial institutions negotiate with each other, the official rate will not change since the money supply is constant. On the other hand, the market interest rate is influenced by financial institutions and referred to when financial institutions trade with each other. This rate is generally higher than the official cash rate because it contains an element of risk. The government can change the cash rate through open market operations that buy or sell government securities. The cash flow rate is an indicator of available liquidity in the economy. When the government intends to increase the interest rate, it sells government securities to banks and financial institutions. In such a situation, banks and other financial institutions buy the securities, which leads to a decrease in the money supply. When the money supply decreases, market forces cause interest rates to rise since there are comparatively less funds in the economy (Global-Rates.com). This concept is illustrated in the graph where we can see that when the money supply decreases, interest rates increase since the demand for money does not change. Therefore... middle of paper ...... reduce the reserve requirement ratio and curb investment and aggregate demand. (Australia)Works CitedAustralia Reserve Bank of Measures of Consumer Price Inflation [Online] // Reserve Bank of Australia. - http://www.rba.gov.au/inflation/measures-cpi.html.College Harper Monetary Policy [Online] // Harper College. - http://www.harpercollege.edu/mhealy/eco212/lectures/moneypol/mp.htm.Finpipe Monetary Policy [Online] // Finpipe. - http://www.finpipe.com/monpol.htm.Fuentes Gilberto The effect of interest rates on inflation and unemployment [Online] // eHow. - http://www.ehow.com/info_7745833_effect-interest-rates-inflation-unemployment.html.Global-Rates.com RBA Official Cash Rate, Australian central bank interest rate [Online] // Global- Rates.com. - http://www.global-rates.com/interest-rates/central-banks/central-bank-australia/rba-interest-rate.aspx.