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Unit 2

Interest rates; the effects of interest rates; Inflation; Exchange rates

Table of Contents

I’m so interested in interest rates! – said nobody ever

Saving and borrowing

So assuming you know about interest rates and didn’t just spend the last two years playing games in class and chewing gum…

We know that people earn interest when making a deposit with a financial institution, and that financial institutions charge interest when you borrow money from them. Naisu.

People who lend money have spare money have a surplus while people who need more money have a deficit.

Short-term/Long-term interest rates

  • Short-term interest rates tend to be for shorter terms like from 1-12 months
  • Long-term interest rates tend to be quite long going up to 20 years!!

Interest rates are usually controlled and/or influenced by the Reverse Bank of Australia (the RBA).

  • High interest rates encourage and incentivises saving in order to prevent an economy from expanding too quickly
  • Low interest rates discourages saving in order to encourage consumer spending

Fixed interest rates

  • Fixed loan for the entire term
    • Protection from unexpected rate increases (but also cannot take advantage from rate decreases)
    • Predictable payments
    • Early payout penalty if the loan is cleared before the expiration of the term

Variable interest rates

  • Variable loan that moves up and down over the term
    • If interest rates fall, repayments reduce (but if they rise, repayments increase)
    • Maintaining the higher repayment means you can shorten the term of the loan
    • Additional repayments don’t incur a penalty
    • You might have to increase repayments if you can’t pay back within the agreed term

Other loans

  • Combination loan - fixed for an initial period (usually up to 10 years) then reverts to variable rate
  • Split loan - Part of the loan is fixed and part of the loan is variable (usually more fixed than variable)

Effects of interest rates

Rising interest rates encourage saving, while falling interest rates discourage saving.

Variable interest rates can affect whether someone can pay their loan, and whether they’ll be inclined to take a new one. Sometimes, when people can’t pay back their loans, they have to default on it. Oops.

Define default The inability to repay borrowed money.

So this basically means, that people have to choose between a safe, fixed interest rate that can end up being more expensive, or a riskier, variable interest rate that could put you in the red zone if interest rates go up.

People can choose, yknow. And that’s what we call a personal investment strategy. So, yea, go ahead and start showing off on r/wallstreetbets.


RBA Inflation Calculator Inflation and its Measurement (RBA)

Calendar Year: A basket of goods and services valued at $100 in calendar year 2000, would in calendar year 2015 cost $150.6.

Inflation is the increase in the level of prices of goods and services. They typically rise (but can also fall - this is known as deflation.)

You can calculate the inflation rate using the inflation rate formula.

hopefully that appears right.

Anywayyyyyyyy…. it might also help to know that Australia’s inflation rate is at 2-3%. We measure inflation using the Consumer Price Index (CPI) (calculated by the ABS) which measures the percentage change in the price of a basket of goods and services consumed by households. It is representative of typical consumer spending.

Exchange rates

Exchange rates are the rate at which one currency is exchanged for another. For example, when A$1 = US$1.05 that means 1 Australian dollar is worth 105 US cents. Ha ha, the days when that was still true (this textbook is so old!)

Anyway, because exchange rates are floated, it means they fluctuate based on supply and demand. When one currency increases it value against another this is known as an appreciation, and the other way around is known as a depreciation.


  • An appreciation will raise the price of Australian dollars in terms of foreign currencies
  • Exports become more expensive (reducing international competitiveness, worser for exporting businesses)
  • Imports become cheaper (this is better for consumers)


  • A depreciation will lower the price of Australian dollars in terms of foreign currencies
  • Exports become cheaper (increasing international competitiveness, better for exporting businesses)
  • Imports become cheaper (this is worser for consumers)

Balance of trade

  • When imports > exports this creates a negative balance of trade that can lead to foreign debt.
  • When exports > imports then we have a positive balance of trade which can lead to surplus.

**The balance of trade is the difference between the value of a nation’s imports and the value of its exports.

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