Questions for Week 6 Flashcards
(17 cards)
What are the three functions of money, and does cryptocurrency fulfill them?
Money functions as a medium of exchange, unit of account, and store of value. Cryptocurrency fulfills these in limited contexts but lacks widespread stability and acceptance to fully serve as money.
Why must the velocity of circulation (V) be constant in the Quantity Theory of Money, and is this likely?
For the Quantity Theory MV=PY to predict inflation accurately, V should remain stable. However, V can fluctuate with economic changes, making constancy unlikely in practice.
What are Open Market Operations (OMO)?
OMO are the buying and selling of government securities by the central bank to control the money supply and interest rates. Buying increases reserves and lowers rates; selling reduces reserves and raises rates.
How does the RBA conduct monetary policy through interest rates?
The RBA sets a target cash rate, affecting borrowing costs economy-wide, and adjusts it via OMO to influence aggregate demand and maintain price stability.
What is the money multiplier, and why is it generally greater than 1?
The money multiplier = 1/reserve ratio, indicating how deposits expand through fractional-reserve banking. It exceeds 1 because each dollar of reserves supports multiple dollars in deposits.
In what situation would the money multiplier equal 1?
The multiplier equals 1 in a 100% reserve banking system, where banks keep all deposits in reserves, so an increase in reserves raises the money supply by exactly that amount.
If the initial money supply is $1000 with a reserve ratio of 0.2, what happens if bank reserves increase by $5?
The money multiplier = 1/0.2 = 5. A $5 increase in reserves would increase the money supply by 5×5=25.
What is the Keynesian cross, and how is equilibrium output determined?
The Keynesian cross graphically represents equilibrium where planned aggregate expenditure (PAE) equals actual output (Y), indicating no unintended inventory accumulation or depletion.
Given C=2,600+0.8(Y−T)−10,000r, Ip=2,000−10,000r, G=1,800, NX=0, and T=3,000, how do you find equilibrium output?
Calculate PAE: PAE=4000−20000r+0.8Y. Set PAE=Y and solve for Y, where Y=10000 when r=0.1.
What is a policy reaction function (PRF)?
The PRF describes how the central bank adjusts the interest rate in response to deviations in inflation or output from their targets, helping maintain stability.
How does the Taylor Rule guide interest rate policy?
The Taylor Rule suggests adjusting the nominal interest rate based on deviations of inflation from its target and the output gap, providing a systematic framework for rate decisions.
If potential output Y* is 12,000 and the real interest rate is 10%, what interest rate should the RBA set to achieve full employment?
With Y=12,000, solve for r in Y=4000−20,000r+0.8Y, yielding r=0.08. The RBA should lower the interest rate to 8% to reach full employment.
How should the RBA adjust the interest rate if Y*=9,000 and current output is higher than potential?
An expansionary gap suggests overheating; raising r by 1% to 11% would reduce PAE by 200, bringing output back to potential.
Given real GDP = $8 trillion, nominal GDP = $10 trillion, M1 = $2 trillion, and M3 = $5 trillion, calculate velocity for M1 and M3.
For M1, V=Nominal GDP/M1=10/2=5; for M3, V=Nominal GDP/M3=10/5=2.
Show that the Quantity Equation holds for both M1 and M3 in this example.
For M1, M×V=2×5=10; for M3, M×V=5×2=10, consistent with the Quantity Equation MV=PY.
How does a higher interest rate affect bond prices?
Higher rates lower bond prices, as existing bonds yield less relative to new bonds issued at higher rates, making them less attractive.
How does the Reserve Bank use interest rates to influence inflation?
By raising rates, the RBA reduces borrowing and spending, cooling inflation. Conversely, lowering rates encourages economic activity, supporting demand and price levels.
