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Question 1. In response to concerns about a recession the Reserve Bank of Australia (RBA)
decides to raise its official inflation target.
(i) On a diagram, illustrate and explain the likely impact of a decrease in the target cash rate on the
equilibrium price and quantity of 180-day Treasury Bills
(ii) Using a money market equilibrium diagram, illustrate and explain that if the RBA sets the
interest rate it cannot control the level of money stock when there is a change in money demand
(iii)On a diagram, show what happens to the RBA’s reaction function if it raises its official
inflation target
Question 2. An economy is described by the following equations:
C = 10 + 0.8(Y – T) – 100r
IP = 10 – 100r
G = 100
NX = 0 (Assume it is a closed economy)
T = 100
Y* = 150, potential output.
The monetary policy reaction function is given by
r = 0.05 + 0.25 (π – πT),
Note that π is the actual rate of inflation and πT is the target rate of inflation
(i) What is the size of the multiplier in the above model economy
(ii) Suppose that the government is planning to increase purchases (G) by 20 and increase taxes (T) by 25. What would be the change in equilibrium income? Show your working
(iii) Assume that G = T = 100 and the current real interest rate (r) is 0.1 (i.e. 10%). Determine
the output gap
(iv) Determine the real interest rate that will eliminate the output gap in part (iii)
(v) Assume that the target inflation rate (πT) is 3%. What is the actual inflation rate
corresponding to the real interest rate determined in part (iv)?
Question 1. In response to concerns about a recession the Reserve Bank of Australia (RBA)
decides to raise its official inflation target.
(i) On a diagram, illustrate and explain the likely impact of a decrease in the target cash rate on the
equilibrium price and quantity of 180-day Treasury Bills
(ii) Using a money market equilibrium diagram, illustrate and explain that if the RBA sets the
interest rate it cannot control the level of money stock when there is a change in money demand
(iii)On a diagram, show what happens to the RBA’s reaction function if it raises its official
inflation target
Question 2. An economy is described by the following equations:
C = 10 + 0.8(Y – T) – 100r
IP = 10 – 100r
G = 100
NX = 0 (Assume it is a closed economy)
T = 100
Y* = 150, potential output.
The monetary policy reaction function is given by
r = 0.05 + 0.25 (π – πT),
Note that π is the actual rate of inflation and πT is the target rate of inflation
(i) What is the size of the multiplier in the above model economy
(ii) Suppose that the government is planning to increase purchases (G) by 20 and increase taxes (T) by 25. What would be the change in equilibrium income? Show your working
(iii) Assume that G = T = 100 and the current real interest rate (r) is 0.1 (i.e. 10%). Determine
the output gap
(iv) Determine the real interest rate that will eliminate the output gap in part (iii)
(v) Assume that the target inflation rate (πT) is 3%. What is the actual inflation rate
corresponding to the real interest rate determined in part (iv)?