Tutorial Questions

1. Which of the following is Australia's primary goal of monetary policy?

a. Lowering the rate of unemployment
b. Increasing the value of the Australian dollar relative to other currencies
c. Economic growth
d. Price stability
2. According to the Reserve Bank of Australia, inflation targeting refers to
monetary policy that aims to
a. A particular annual inflation rate on average over the business cycle.
b. achieve the same low rate of inflation every year.
c. control the money supply to achieve a target rate of inflation.
d. control the money supply to achieve a target rate of interest that will
ensure a low inflation rate.
 Since the early 1990s, the Reserve Bank has used an inflation target to achieve its
monetary policy objectives. Maintaining low and stable inflation is important for
achieving sustainable growth in economic activity and employment.
3. The Board of the Reserve Bank of Australia has stated that they focus on
which of the following as their primary goal of monetary policy?
a. Stability of financial markets
b. Low inflation
c. Economic growth
d. High labor force participation rate
4. The Reserve Bank of Australia targets a per annum inflation rate, on
average over the business cycle, of between __
a. 1 per cent and 2 per cent
b. 2 per cent and 4 per cent
c. 3 per cent and 4 per cent
d. 2 per cent and 3 per cent
5. Money demand will increase if the price level __ or if real GDP __
a. increases; decreases
b. decreases; decreases
c. increases; increases
d. decreases; increases
6. Open market operations occur when the Reserve Bank of Australia
a. purchases or sells corporate shares in the market to control interest rates.
b. controls the money supply.
c. makes loans to foreign banks.
d. purchases or sells short-dated financial instruments.
7. The Reserve Bank of Australia uses open-market operations
a. usually every day.
b. the Reserve Bank Board meets monthly to discuss monetary policy.
 c. only when it wants to increase or decrease the cash rate.
d. only when it is conducting monetary policy.
 The Reserve Bank of Australia uses open market operations almost every business
day or say usually every day. Open market operations are done to facilitate the smooth
functioning of the payments system.
8. The 'cash rate' is the interest rate
a. the Reserve Bank of Australia charges commercial banks.
b. banks charge their largest customers.
c. banks charge each other for overnight loans.
d. on a government bond or security.
9. The overnight cash rate is determined
a. administratively by the Reserve Bank of Australia.
b. by the supply of and demand for cash.
c. directly by household demand for funds
d. directly by firm demand for funds.
10. Accounts held with the Reserve Bank of Australia (RBA), which financial
institutions use to settle payments between each other and with the RBA,
are called
a. credit accounts
b. real-time gross settlement accounts
c. debit accounts
d. Exchange settlement accounts
Question 1
Suppose the current conditions of the Australian economy are as follows.
Overall growth is very soft due to a considerable decline in business investment.
Demand in the labor market is weaker than usual, and the unemployment rate shows
signs of increasing. At the same time, inflation is sitting lower than the targeted range of
2 - 3%.
Required:
a. Draw an appropriate AD-AS graph to reflect the above conditions the Australian
economy is currently experiencing (e.g., soft growth, declining investment, rising
unemployment, and lower inflation rate).
 b. Given the economic conditions described above, what type of monetary policy
does the Reserve Bank of Australia (RBA) need to implement? Clearly explain
why such a policy is needed.
RBA needs to implement the expansionary monetary policy. As the current GDP is
below the potential GDP, RBA should find ways to grow AD so that GDP can catch up
c. Clearly explain the steps the RBA must undertake with its Open Market
Operations (OMOs) to implement the monetary policy recommended in part (b).
The RBA must cut the cash rate, using the Open Market operations
- The RBA buys short-term government bonds from commercial banks
- The RBA will pump new money in commercial banks’ reserves. The bank’s
reserves to increase
- Banks have more reserves to lend each other -> charge a lower interest rate =
cash rate
- RBA hopes banks follow suit and cut the interest rates they’re charging their
customers. Interest rates in the economy will decrease.
Question 2
Suppose the economy is currently in a recession, and economic forecasts indicate that
the economy will soon enter an expansion. What is the likely effect of the expansion on
the expected profitability of new investment in plant and equipment? In the market for
loanable funds, graph and explain the impact of the forecast of an economic expansion,
assuming borrowers and lenders believe the forecast is accurate. What happens to the
equilibrium real interest rate and the quantity of loanable funds (ceteris paribus)? What
happens to the amount of savings and investment?

If an expansion was to happen in the economy, the likely effect on expected profitability
of new investment in plant and equipment will increase. As the economy is in an
expansion phase or growth stage, there will be an increase in economic activity and
investment, thus more demand for plant and equipment. This in turn leads to higher
expected profitability. During an economic expansion, the demand for loanable funds
will shift to the right, as there is more activity and investment in the economy, requiring
loanable funds. The equilibrium real interest rate and the quantity of loanable funds will
increase, as there is more demand for loanable funds. The quantity of saving will
decrease as many firms and individuals will see this as an opportunity to invest. The
quantity of investment will increase.
Question 3
Assume that the Reserve Bank of Australia considers the inflation rate too high. What
action would you expect it to take in response to this situation? Carefully explain how
this action will affect the economy in the short run. Through what channels will these
effects take place? Use diagrams where appropriate.

When inflation is too high, the Reserve Bank of Australia typically raises interest rates to
slow the economy and bring inflation down. To lower inflation, they could increase r by
one percentage point and so raise the real interest rate at any given inflation rate, a
move that we will refer to as an autonomous tightening of monetary policy. This
autonomous monetary tightening would shift the monetary policy curve upward by one
percentage point, from MP1 to MP2 in Figure 2, thereby causing the economy to
contract and inflation to fall.
By increasing borrowing costs, rising interest rates discourage consumer and business
spending, especially on commonly financed big-ticket items such as housing and capital
equipment. Rising interest rates also tend to weigh on asset prices, reversing the wealth
effect for individuals and making banks more cautious in lending decisions.