Chapter 12_ Part B

Question 1

Define monetary transmission mechanisms.

Answer 1

Changes in monetary aggregates and how they are linked to demand, output, employment and inflation.

Question 2

What causes the changes in monetary aggregates in a floating exchange rate system?

Answer 2

• Changes in the official rate at which the central bank finances shortage of liquidity in the money market
• A change in the money supply
• Changes in the credit extension regulations or direct controls

Question 3

What does Figure12.10 show?

Answer 3

It shows that the change in the official interest rate ( Repo rate in SA), has a direct bearing effect on financial markets.

Question 4

What does the change in the official rate mean?

Answer 4

-Money markets will be affected by changes in money market rates
-Debt market will be affected by changes in long term interest rates
-The bond, equity and fixed property market will be affected by changes in assets prices
-Foreign exchange market will be affected by changes in the nominal and real effective exchange rates

Question 5

What will these changes lead to?

Answer 5

-These changes spill over to the goods and labour market as well as into transactions in international markets
-This could in turn lead to secondary effects on real economic activity and inflation.

Question 6

How does the operational variable of monetary policy work largely?

Answer 6

Through its influence on aggregate demand, having minimal impact on the supply of goods, services and labour.

Question 7

True or False. Monetary policy affects real economic activity over the short and long run.

Answer 7

False
-Monetary policy only affects real economic activity over the short run, while it is generally considered to be neutral over the long run.
- Through these short-term effects on aggregate demand, it is able to contain increases in nominal wages and inflation.

Question 8

List the main channels through which monetary policy influences prices, wages and output.

Answer 8

-Short-term interest rate channel
-Long-term interest rate channel
-Domestic asset price channel
-Exchange rate channel

Question 9

Why is there a link between the official interest rate and short-term interest rates in an economy?

Answer 9

Because official lending rates are the rates at which central banks are willing to provide cash reserves to banks.

Question 10

What happens as a result of these links?

Answer 10

Any changes in the repo rate is usually quickly reflected in the short-term interest rates in the money market and after a short while, also in the deposit rates of banks.

Question 11

What does the official interest rate influence?

Answer 11

The shortages of required and free, or excess reserves that banks may experience.

Question 12

Why does the official rate place ceilings on the level of other lending rates in the money market

Answer 12

-Because shortages can be financed in all instances at this rate.
- No bank operating in a rational manner would finance such a shortage at a higher rate than the official rate

Question 13

Why does the official rate place a floor on the level of other lending rates in the money market

Answer 13

The surplus of banks can be deposited at the central bank
- No banks would be willing to place funds on deposit at lower interest rates.

Question 14

What does this system of accommodation restrict?

Answer 14

The volatility of money market interest rates between these ceiling and floor values of accommodation.

Question 15

What does the impact of the change in the official interest rate on the short-term interest rates depend on?

Answer 15

• Whether the change was anticipated
• Whether it is expected to be reversed in the near future
• If it is expected to be one change in a series of changes in the same direction

Question 16

What happens when the change in the repo rate was expected?

Answer 16

short-term interest rates would have started to reflect the expected change.

Question 17

What will happen if repo rate change not expected to last (reverse expected)?

Answer 17

then changes in the market rates may not fully reflect the extend of the changes in the repo rate.

Question 18

What will happen if repo rate change is expected to last and a series of changes in the same direction is expected?

Answer 18

changes in the market rates would even be higher than changes in the repo rate.

Question 19

What will an increase in the official interest rate that is not expected to be reversed quickly lead to?

Answer 19

More or fewer corresponding increases in short-term market interest rates.

Question 20

What will a decline in the official rate lead to?

Answer 20

It will lead to a reduction in the short-term interest rates.

Question 21

What do the changes in short-term interest rates have a direct impact on?

Answer 21

On the cash flow or liquidity of firms, household, depending on whether they are net savers or net borrowers.

Question 22

What will happen to net borrowers if there is an increase in the short-term interest rates ?

Answer 22

Cash flow will be reduced

Question 23

What will happen to net savers if there is an decrease in the short-term interest rates ?

Answer 23

Cash flow will be reduced

Question 24

What does the macroeconomic effect of a change in the official interest rate depend on?

Answer 24

On whether firms and households are net savers or net borrowers.