Question

（1）Briefly describes the ways in which the Reserve Bank of Australia (RBA) can influence the money supply?

（2）Explain the roles of monetary and fiscal policy in causing and ending hyperinflations.

Answer 1

1) Reserve Bank of Australia can control or influence the money supply in following ways

By open market operations: The central bank can buy and sell government bonds in order to control money supply. So if central bank wants to reduce the money supply, it would sell the securities and take the money out of the economy and vice versa.

The Reserve Bank can also influence the Reserve requirements. If the reserve rate is high, banks would need to keep a larger proportion of money with themselves and hence would be able to lend less which would mean a lower money supply. If the reserve rate is less , more could be lend and hence a higher money supply.

The other factor is discount rate or bank rate ie the rate at which the reserve Bank lends to commercial banks. If the rate is high, the banks would keep higher proportion of money with them and hence the money supply would reduce and vice versa.

2) Hyperinflation is the type of inflation wherein the prices are extremely high ie the inflation is three digit rate annually. It erodes the value of money quickly.

Hyperinflation is caused when there is huge supply of money ie the government is printing money, which is a monetary policy. In order to finance its deficit, the government prints money and this leads to large money supply. When money supply is more, the value of money reduces and there is inflation. Hence monetary policy could be a cause of Hyperinflation.

The government can end the hyperinflation by fiscal policy ie the government should stop the printing of money. Rather it should focus on fiscal aspect and increase the taxes and reduce government spending. This would mean that the aggregate demand would reduce and it would help control inflation. Also the government would be able to finance its deficit as well without the need to print money.

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