Monetary Policy Questions from EA

Inflation targeting

• guarantees that inflation remains within a band of 2% to 3%

• assists with managing an economy’s inflation expectations

• encourages the banking sector to pass on rate changes

• is most effective with cost-push inflation issues

If the Reserve Bank of Australia increases interest rates relative to our trading partners, it will cause (ceteris paribus)

• a depreciating effect on the exchange rate.

• a reduction in the federal budget deficit.

• an inflow of foreign financial capital.

• a decrease in export prices.

Australia’s monetary policy is less effective when the economy is

• recovering, because excess production capacity limits employment growth.

• in a trough, because the average propensity to save is high due to lower consumer confidence.

• in a downturn, because political considerations discourage potential reductions in the cash rate.

• booming, because businesses are concerned that interest rates will rise so they reduce their investments.

Assume there is an increase in Australians preferring to rent rather than buy their own home. The effect on the transmission mechanism would be (ceteris paribus)

• a change to how the transmission mechanism is channelled.

• a decrease in the effective size of the transmission mechanism.

• quicker interest rate changes so banks maintain their profit levels.

• a shorter time frame for the cash rate to be transmitted throughout the economy.

Assume a central bank is concerned that house prices have increased in the past year. Which situation would be most likely to encourage the central bank to increase the official interest rate?

• Inflation increases from below 1% and housing approvals continue to rise.

• There is a short-term increase in house purchases causing current consumption to fall.

• There is a continuous increase in both house prices and consumer debt relative to wage growth.

• The housing price index increases in capital cities and does not change in other populated areas.

The results of a cash rate decision are a reduction in interest payments on debt and an increase in the amount of income available for households and businesses. Which channel of the transmission mechanism is this cash rate change an example of?

• savings and investment

• asset prices and wealth

• sector income

• cash flow

In a situation where monetary policy is changed, the transmission mechanism will depend on:

• changes to the structure of the economy over time.

• asset and wealth values of high-income households.

• the substitutability of imports and domestic goods and services.

• whether households and firms respond by saving more now or later.

Which country would be most likely to experience a longer time lag in economic growth following a cash rate change (ceteris paribus)?

• a country where marginal propensity to consume is 0.7

• a country where marginal propensity to import is 0.7

• a country where marginal propensity to invest is 0.7

• a country where marginal propensity to save is 0.7

Identify the most likely outcome of the movement in interest rates discussed in the statement.

• Household consumption levels in Australia would continue to rise.

• Production pressures in the Australian economy would decrease.

• The Australian economy would be moved from its equilibrium.

• The Australian dollar would depreciate against the US dollar.

Which of the following best represents the effect of the Reserve Bank of Australia reducing the cash rate?

• return on investments reduced, cost of investing increased

• house repayments reduced, housing borrowing increased

• spending decreased, rate of savings increased

• inflation reduced, import prices increased