Week 3 - Central Bank

Question 1

What is the role of the central bank?

Answer 1

• They create fiat money
• are in charge of monetary policy
• responsible for financial stability in the economy.
• To achieve stable price levels and to minimise inflation using monetary policy, namely interest rates as policy instrument.

Question 2

Monetary Policy

Answer 2

• Is used to control interest rates in an economy.
• Affects how much money is the economy and how much it costs to borrow.

Question 3

Correlation between low unemployment and inflaiton.

Answer 3

At low unemployment, wages setting power increases, thereby increasing wages in an economy, and therefore causing inflation to rise.

Question 4

Demand-Pull Inflation

Answer 4

When is unemployment is high in an economy, this is typically an indication of a weaker labour market. Consequently consumer purchasing power is reduced and there is less demand for goods and services, thereby pushing down prices and resulting in lower inflation

Question 5

Cost-push inflation

Answer 5

During periods of low unemployment the wage setting power of workers increases as a consequence of a tighter labour market. This leads to an increase in wages, and higher prices as producers pass on higher production costs onto consumers. This is known as cost push inflation.

Question 6

70’s oil crisis and its relationship to inflation and unemployment.

Answer 6

1. On inflation - The 70’s oil crisis led to an massive increase in the price of oil. Oil is a crucial imput in the production process for numerous industries. Consequently, a rise in oil prices, led to signicifcant rises in production costs, which producers passed onton consumers in the form of higher prices. Known as cost push inflation.
2. On Unemployment - Increased production costs led to significant downsizing in an attempt to cope with higher costs.

• Conventional economic theory points towards an inverse relationship between these two variables. That is, as when unemployment is high, inflation is low and vice versa. However the oil crisis a notable charactersi

Question 7

70’s oil crisis and its relationship to inflation and unemployment.

Answer 7

1. On inflation - The 70’s oil crisis led to an massive increase in the price of oil. Oil is a crucial imput in the production process for numerous industries. Consequently, a rise in oil prices, led to signicifcant rises in production costs, which producers passed onton consumers in the form of higher prices. Known as cost push inflation.
2. On Unemployment - Increased production costs led to significant downsizing in an attempt to cope with higher costs.

• Conventional economic theory points towards an inverse relationship between these two variables. That is, as when unemployment is high, inflation is low and vice versa. Interestingly the oil crisis produced both high inflaiton and unemployment. This notable characteristic is known as stagflation.

Question 8

Supply shocks

Answer 8

Moves the Phillips curve by changing the labour market equilibrium. That is levels of production in an economy.
One example of a supply shock in the oil crisis in the 70s.

Question 9

IS Curve

Answer 9

• reflects demand side (equilibrium in the goods market).
• shows the combination of interest rates and output where demand (Yd) is equal to output y.

Question 10

Phillips Curve

Answer 10

Reflects supply side (unemployment-inflation relationship)

Question 11

MR curve

Answer 11

how the central bank responds to supply and demand shocks.