Monetary Policy Flashcards

Question

what does this figure show

Answer 1

shows interest rate targeting the money supply will be adjusted to whatever level is necessary to keep the rate of interest at the rate targeted by the RBA. In this figure the target rate of interest is 7 per cent The equilibrium is 1800. 1800 money supply is required to keep interst at 7

Answer 2

It was used by RBA in the 70s and 80s. Monetary policy was used to control the size and growth rate of money supply

Answer 3

increasing money supply --\> more funds were available decreasing money supply --\> reduced availability of funds

Answer 4

financial innovation, the huge growth of credit and the growth of the private sector’s ability to affect the money supply via private bonds, securities and loans abandoned in the 1990s, now use interest rate targeting

Answer 5

the loanable funds model is concerned with the long-term real rate of interest and the money market model is concerned with the short-term nominal rate of interest.

Answer 6

savers consider purchasing a long-term financial investment such as a corporate bond. firms which are borrowing to finance long-term investment projects households who are taking out a mortgage loan

Answer 7

it is the interest rate most affected by increases and decreases in liquidity

Answer 8

usually smaller than it is on short-term interest rates and the effect may occur after a lag in time.

Answer 9

the total level of spending in the economy.

Answer 10

Encourages saving and discourages borrowing (discourages current and future consumption) net borrowers: higher interest rate --\> lower future income substitution effect will create a negative income effect

Answer 11

Households can use their savings to buy other assets such as real estate or shares, or to contribute to superannuation funds. change in interest rates may have more of an effect on the composition of households’ **existing wealth**

Answer 12

uncertain substitution effect works to discourage current consumption but there will be a positive income effect higher interest rate --\> increase future income --\> increases wealth --\> encourages current and future consumption

Answer 13

. If the substitution effect is stronger than the income effect, current consumption will still fall and saving will increase. If, however, the income effect is stronger, there will be a rise in current consumption and a fall in saving.

Answer 14

increases the cost of borrowing ## Footnote increased opportunity cost of using profits if interest rates rise

Answer 15

If interest rates in Australia rise relative to interest rates in other countries, investing in Australian financial assets becomes more desirable, causing foreign investors to increase their demand for dollars, which increases the value of the Australian dollar. As the value of the dollar increases, **_net exports will fall._**

Answer 16

(1) the economy experiences continuing inflation, with the price level rising every year, (2) the economy experiences long-run growth, with the long-run aggregate supply (LRAS) curve shifting to the right every year.

Answer 17

As the population grows and incomes rise, consumption will increase over time. as the economy grows firms expand capacity and new firms are established, increasing investment spending. an expanding population and an expanding economy require increased government services, such as more teachers and police officers, so government purchases will expand.

Answer 18

first year: economy is at potential GDP, $1000 and price level 100 2nd yr, LRAS increases to $1100 BUT AD only increases from AD1 to AD2(_{w/o policy)}, the economy will be at macroeconoimc equilibrium at B (where AD_{2(w/o policy)} intersects with SRAS₂), below potential GDP at C (where AD_{2(w/o policy)} intersects with LRAS₂) --\> *firms are operating at less than their normal capacity, below full employment --\> Incomes and profits will fall, firms will begin to lay off workers and the unemployment rate will rise.* By lowering interest rate, increase in consumption, investment and net exports shift AD_{2(w/o policy)}to AD2 (with policy)

Answer 19

since it may take months for data to be gathered and analysed, RBA may not immediately recognise the need to tighten or loosen the monetary policy

Answer 20

No, decided montly

Answer 21

the time it takes for interest rate changes to affect real GDP investment by its nature cannot be changed quickly—most investment projects are already committed to or are ongoing, **and it is only proposed projects that may be altered**. Therefore the full impact of a monetary policy change may take **up to two years,** or sometimes longer.

Answer 22

Economy at equilibrium at potential GDP at $930 and Price level of 100 in year 1 in Year 2, LRAS1 shifts to LRAS2, SRAS1 shifts to SRAS2, AD1 shifts to AD2 (w/o policy), SR equilibrium at B, but this above potential GDP increase interest rate --\> reduce aggregate demand --\> AD2(w/o policy) to AD2(w policy), equilibrium at potential GDP at C

Answer 23

slowing down the economy ## Footnote High rates of interest will effectively reduce most components of aggregate demand—**new investment will fall**, **some consumer spending** will decline and **earnings from exports** will fall due to the higher exchange rate that accompanies higher interest rates.

Answer 24

During a recession business confidence is at a very low level * Businesses will be unwilling to borrow money for investment when they are uncertain of their own viability, and are uncertain about the ability to generate sufficient profits to repay loans. Households, given uncertainty and fearing low wages or even unemployment, may wish to increase their savings or reduce debt by reducing consumption.

Answer 25

a number of countries experiencing severe recessions after the 2007–2008 GFC, nominal interest rates were zero, or almost zero, but this wasn’t sufficient to restore borrowing or economic growth.

Answer 26

increase in interest rate --\> australian assets become more profitable --\> $AU appreciates --\> agriculture, manufacture and service sector lose international competitiveness

Answer 27

marginal borrowers and lower income earners who generally have little savings do not benefit, and face higher interest repayments on loans, which can often impose severe hardship cf people with savings benefit

Answer 28

While it can be very effective in achieving its policy goal, the impacts on people are unequal.

Answer 29

financial institutions in Australia are not required to alter their interest rates when the RBA changes monetary policy --\> independent moves can prevent the RBA from implementing monetary policy effectively e.g. During GFC major Australian banks still experienced a fund shortage --\> from early 2008 and continuing through to the end of 2010 all of the major banks in Australia i**ncreased their interest rates independently** of the RBA numerous times—moving outside the RBA’s target range.

Answer 30

1. provides a benchmark to measure performance 2. households and firms can form accurate expectations of future forecast --\> improve their planning 3. institutionalise good monetary policy --\> new board members would stick to the inflation target

Answer 31

1. numerical target for inflation reduces the flexibility of monetary policy to address other policy goals, such as unemployment, economic growth or exchange rate management. 2. Second, inflation targeting assumes that the RBA can accurately forecast future inflation rates, which is not always the case.

Answer 32

To avoid inflation 1. . Government will be tempted to sell bonds to RBA rather than public. RBA purchases these bonds --\> money supply increases --\> inflationary pressures rise 2. if gov controls central bank, use it to further political interests e.g. difficult to be elected during high unemployment --\> tempted to decrease interest rate --\> inflationary pressures rise

Answer 33

During the lead-up to the November 2007 federal election in Australia the RBA increased interest rates—the first time it has ever done so during an election campaign, confirming its independence.

Answer 34

Members of RBA do not have to run for election, they are not held accountable by voters - democratic system? Argued RBA should act like executive branch- gov should * members of RBA would serve as long as gov wanted them to * If gov didnt like monetary policy, could dismiss and replace members * When the government ran for re-election **the voters would have an opportunity to express their approval or disapprova**l of the government’s actions regarding monetary policy.