Chapter 13

Question 1

Monetary policy?

Answer 1

The setting of money supply by the central bank (Reverse Bank of Australia). This is done by the RBA setting reserve ratios of banks in the financial sector, setting interest rates as a lender of last resort and its open market actions (buying and selling of government bonds).

Question 2

Objectives of monetary policy?

Answer 2

Price stability, low inflation
Maintenance of full employment/low unemployment
Welfare of people in Australia

Question 3

Price stability?

Answer 3

Refers to managing inflation target (2-3%),
Inflation is the general rise in the price of goods
Helps people plan purchases and form decisions (consumer spending, property purchasing, investment and confidence)

Question 4

Full employment?

Answer 4

Full productivity, economy is efficient

Problem -> multiplier

Question 5

Welfare of people in Australia?

Answer 5

Able to consume more, greater utility, greater standard of living (measured by how much you consume

Question 6

What’s the RBA’s goal?

Answer 6

Manage money supply (impacts on unemployment, bank behaviour, inflation, confidence, foreign investment/trade

Question 7

What does the RBA do and what are its tools?

Answer 7

Sets reserve levels of banks in financial sector (reserve ratio).

Tools - banking regulation, open market operations and the discount rate.

Question 8

Strengths of monetary policy?

Answer 8

Flexible - implementing it whenever the RBA feels like they need to.
Has greater political neutrality - independent of the government.
Effective during boom periods.
Very effective under floating E.R’s -> cuts in I.R’s leads to a fall in capital inflow, reducing demand for the currency leading to a depreciation.

Question 9

Weaknesses of monetary policy?

Answer 9

Suffers from time lags - recognition, decision, action/implementation -> changes to economic conditions, time to make decision.
Less effective during a recession/contraction -> because the need to reduce I.R’s.
Blunt policy instrument - cannot be used to target particular sectors of the economy or certain industries.
QE leads to asset price inflation (stocks, bonds) rather than additional demand in the real economy.

Question 10

Cash rate?

Answer 10

Interest rate on overnight loans in the monetary policy.

Question 11

Contractionary monetary policy (trying to raise cash rate when…)

Answer 11

Economy is growing too fast
Actual GDP is above potential GDP
Unemployment is below the natural rate 
Inflation is above the target range 
The economy is hit by a positive AD shock

Question 12

Expansionary monetary policy (trying to lower the cash rate…)

Answer 12

Economy is growing below the average rate of growth
Actual GDP is below potential GDP
Unemployment is above the natural rate
Inflation is below the target range
The economy is hit by a negative AD shock

Question 13

Interest rates? #1

Answer 13

When I.R’s are low, borrowers will find it easier to pay back loans so they will borrow and spend more. However, when interest rates are high, they borrow less and therefore spend less.
Influencing; private sectors, decisions regarding consumption, saving and investment.

Question 14

Changing interest rates/cash rates…

Contractionary, expansionary and natural.

Answer 14

RBA raising cash rate - stance is said to tighten, therefore adopting a contractionary stance.
RBA lowering cash rate - stance is said to ease, therefore adopting a expansionary stance.
Adopting a neutral stance means - setting I.R is neither stimulatory nor contractionary.

Question 15

Nominal interest rates?

Answer 15

Not adjusted for inflation and tend to reflect the changes in inflation.

Question 16

Real IR?

Answer 16

Nominal rate - inflation rate.

Question 17

Explain the monetary transmission mechanism and discuss how the reserve bank uses monetary policy to stabilise the economy.

Answer 17

RBA is a producer of currency which is distributed out using the financial sector.
It has affect in his much is lent out to firms, households and foreigners.

Question 18

Increase in E.A = Increase in I.R therefore…

Answer 18

Businesses react to demand - goods and services.
Increases demand for money if the firm has to borrow money.
RBA tries to contract the activity so interest rates are forced up through tight monetary policy.

Question 19

Recent monetary policy statistics…

Answer 19

2014-2016 we’ve been in an expansionary stance.
Recovering from end of mining boom and collapse in ToT.
Chinese economy slowing down contributed to our fall in commodities.
Unemployment has risen above natural rate (5%).

Question 20

Role of the financial sector..

Answer 20

Acts as an intermediary between savers/investors (e.g. Financial institutions such as banks). Borrow from firms/individuals with excess funds and lend to those who need funds.

Question 21

Three min types of financial markets?

Answer 21

Loan market - businesses (borrow for C.E), HH (borrow for housing and cars).
Bond market - firms and governments sell bonds to raise finance (e.g. finance budget deficit).
Share market - firms obtaining finance for expansion by issuing new shares through the stock market.

Question 22

Benefits of low inflation?

Answer 22

Protects the value of savings
Improves decision making
Promotes productive investment
Reduces uncertainty which helps to promote long term growth and job creation

Question 23

Target GDP growth?

Answer 23

3-4%.

Question 24

The reserve bank of Australia is responsible for..

Answer 24

Administering monetary policy and maintaining financial stability.

Question 25

What are the reserve banks main objectives in implementing monetary policy?

Answer 25

Prince stability and full employment.

Question 26

Contractionary monetary policy is used when…

Answer 26

Inflation is high, unemployment is low and consumer spending is high.
Vice versa for expansionary.

Question 27

When the RBA wants to pursue a tight monetary policy, which set of actions would be most consistent?

Answer 27

Creating a shortage of funds in the cash market to raise the cash rate.

Question 28

Interest rates definition?

Answer 28

Represent the price of credit - a payment from borrowers to lenders for the use of funds.
Interest represent s the cost of borrowing money overtime.

Question 29

Changes in interest rates affect:

Answer 29

1. Saving and investment decisions
2. Cash flow of HH and firms
3. Wealth and asset prices
4. The exchange rate

Question 30

Simple monetary policy definition:

Answer 30

Refers to interest rate decisions taken by the RBA to affect monetary and financial conditions within the economy - aim of achieving low inflation and sustainable economic growth.

Question 31

Draw contractionary diagram

Answer 31

-

Question 32

Expansionary diagram

Answer 32

-

Question 33

Cash rate diagram

Answer 33

-