Monetary Policy

Question 1

How is contractionary monetary policy implemented

Answer 1

By increasing the cash rate

Question 2

What will the impact of contractionary monetary policy have on the dollar

Answer 2

Banks will be more attractive to depositors compared to international markets where the interest rates are lower

This increases demand for the Australian dollar, which leads to appreciation of the AUD

Question 3

What would lead the RBA to implement contractionary monetary policy ?

Answer 3

1. Inflation targeting
2. Unemployment, growth or output

Question 4

How does contractionary monetary policy affect net exports

Answer 4

If the AUD increases, exports will fall
Imports will increase as they are cheaper. This reduces net exports

Question 5

How does contractionary monetary policy affect GDP

Answer 5

Investment falls as the opportunity cost for borrowing falls

Consumption falls as disposable income falls and consumption of durables falls

Question 6

How does contractionary monetary policy affect the AD curve

Answer 6

AD shifts to the left, employment would be expected to fall

Question 7

true or false; Maintaining a strong dollar in international currency markets is not one of the monetary policy goals of the Reserve Bank of Australia.

Answer 7

False

Question 8

The money demand curve is downward sloping because:

Answer 8

lower interest rates cause households and firms to switch from financial assets to money.

Question 9

If the overnight cash rate falls, then ceteris paribus

Answer 9

interest rates will fall and share prices will rise.

Question 10

According to the Reserve Bank Act 1959 (Cth), what are the goals of monetary policy?

Answer 10

• price stability
• economic growth
• low unemployment

Question 11

The Reserve Bank of Australia’s main monetary policy target is:

Answer 11

the inflation rate.

Question 12

The effect of monetary policy on long-term interest rates is usually:

Answer 12

smaller than its effect on short-term interest rates.

Question 13

Falling interest rates can

Answer 13

increase a firm’s share price, which causes firms to issue more shares, and thus increases funds for investment.

Question 14

what are the major functions of the RBA?

Answer 14

maintaining the integrity of the financial system
monitoring credit growth
controlling the cash rate

Question 15

what characterises the ability of the Reserve Bank of
Australia (RBA) to prevent recessions?

Answer 15

the RBA may be able to keep a recession shorter and milder than it would
otherwise be

Question 16

how does the RBA increase the cash rate?

Answer 16

it sells government securities to commercial banks. This means the commercial banks reserves will decrease causing the cash rate to increase.

Question 17

what situations is one in which the Reserve Bank of
Australia will potentially pursue expansionary monetary policy?

Answer 17

potential GDP is forecast to be higher than equilibrium GDP

Question 18

What is the difference between commodity money and fiat money?

Answer 18

Commodity money is a good used as money that also has value independent of its use as money. Money has four functions: a medium of exchange, a unit of account, a store of value, and a standard of deferred payment. Paper currency is fiat money, which has no value except as money.

Question 19

what is a barter economy?

Answer 19

an economy that does not use money and in which people trade goods and services directly for other goods and services

Question 20

what are the functions of money?

Answer 20

It must act as a medium of exchange.

It must serve as a unit of account.

It must serve as a store of value.

It must offer a standard of deferred payment.

Question 21

what can be accepted as money?

Answer 21

a medium of exchange. at a minimum, be generally accepted as payment to serve as money.

Question 22

Five criteria make a good suitable for use as a medium of exchange:

Answer 22

The good must be acceptable to (that is, usable by) most people.

It should be of standardised quality so that any two units are identical.

It should be durable so that value is not lost by spoilage.

It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported.

The medium of exchange should be divisible because different goods are valued differently.

Question 23

Five criteria make a good suitable for use as a medium of exchange:

Answer 23

The good must be acceptable to (that is, usable by) most people.

It should be of standardised quality so that any two units are identical.

It should be durable so that value is not lost by spoilage.

It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported.

The medium of exchange should be divisible because different goods are valued differently.

Question 24

Explain how financial institutions create money.

Answer 24

On a bank’s balance sheet, reserves and loans are assets and deposits are liabilities. Reserves are deposits that the bank has retained, rather than loaned out or invested, which are kept by banks as part of prudential bank management. When a bank accepts a deposit, it keeps only a fraction of the funds as reserves and loans out the remainder. In making a loan, banks increase the bank account balance of the borrower. When the borrower buys something with the funds the bank has loaned, the seller will deposit the payment in a bank. The seller’s bank will keep part of the deposit as reserves and loan out the remainder. This process will continue until no banks have excess reserves. In this way, the process of banks making new loans increases the volume of demand deposit account balances and the money supply

Question 25

The simple deposit multiplier is

Answer 25

the ratio of the amount of deposits created by banks to the amount of new reserves. An expression for the simple deposit multiplier is 1/reserve ratio.

Question 26

Financial markets and financial intermediaries together comprise the…

Answer 26

financial system

Question 27

The _____ is the interest rate that financial institutions and the RBA charge each other for overnight loans.

Answer 27

cash rate

Question 28

To lower the cash rate, the RBA would

Answer 28

either not sterilise an overnight cash surplus or, if required, would increase overnight liquidity.

Question 29

To increase the cash rate, the RBA would

Answer 29

either not sterilise an overnight cash deficit or, if required, would decrease overnight liquidity.

Question 30

The RBA utilises _______ to manage the cash rate

Answer 30

open market operations

Question 31

Open market operations is

Answer 31

the purchasing or selling of financial instruments such as Commonwealth Government Securities and private bonds and securities, either by outright purchase or sale, or by the use of repurchase agreements

Question 32

Banks and other financial institutions each maintain an ________ with the RBA, which enables the overnight transfer of funds between financial institutions, and between the RBA and financial institutions.

Answer 32

exchange settlement account

Question 33

Monetary targeting is

Answer 33

the use of monetary policy to control the size and rate of growth of the money supply. Monetary targeting is no longer used in Australia and in most developed economies.

Question 34

An _____________ lowers interest rates to increase consumption, investment and net exports

Answer 34

expansionary monetary policy

Question 35

An expansionary monetary policy causes the aggregate demand (AD) curve to shift ______ raising the level of ______________

Answer 35

Right
real GDP and the price level

Question 36

A contractionary monetary policy….

Answer 36

raises interest rates to decrease consumption, investment and net exports

Question 37

A contractionary monetary policy causes the AD curve to shift outwards (rightwards) less than it otherwise would, reducing both the level of real GDP and the______

Answer 37

inflation rate

Question 38

What arguments do economists make in support of the independence of the RBA

Answer 38

Advocates of RBA independence argue that isolating it from political pressure allows the bank to choose policies in the best interests of the economy. Internationally, countries with independent central banks tend to have lower inflation rates.

Question 39

what arguments are used against the independence of the RBA?

Answer 39

the RBA’s independence is not absolute because parliament can pass legislation at any time to reorganise or even abolish it

Opponents of RBA independence argue that concentrating so much power in the hands of unelected officials is inconsistent with democratic principles.