Question

1. With an increase in real GDP, households’ demand for money would _____, thus the RBA has to _____ money supply to the banking system.

2. How exactly can the RBA conduct an expansionary policy, and how can it be represented in AD-AS model?

a. the RBA buys government bonds and Treasury bills, and AD curve shifts right.

b. the RBA sells government bonds and Treasure bills, and AS curve shift right.

c. the RBA increase the required-reserve ratio, and AD curve shift left.

d. the RBA decrease income taxes, and AD curve shift right.

3. If the RBA is very sensitive to changes in the inflation rate and adjusts the target cash rate accordingly to keep inflation rate within a particular band, how would this affect AD curve in AD-AS model?

a. AD curve will shift right.

b. AD curve will shift left.

c. AD curve is relatively steep.

d. AD curve is relatively flat.

Answer 1

1. With an increase in real GDP, households' demand for money would increase, thus the RBA has to increase the money supply to the banking system.

2. The correct option is a.

(a) If the RBA purchases government bonds and treasury bills, the money supply will increase in the people's hands and this will lead to increase in AD. Thus the AD curve will shift towards right.

(b) If the RBA will sell government bonds to people, then with purchasing of these bonds the money quantity with people will decrease. So this is not expansionary policy.

(c) Required reserve ratio is the fraction of money that bank has to keep as reserve. Increasing this ratio will reduce the money that banks can loan out to people. This will reduce the money in hands of people and it is not expansionary policy.

(d) Reduction of income tax is a part of fiscal policy of the government and not expansionary policy.

3. The correct option is b.

(a) AD curve shifting right means increase in demand. But with keeping cash rate in a particular target people will have less money to demand. So AD cannot shift to right.

(b) In order to keep inflation in a particular band, the RBA adjusts target cash rate. So this will make people have limited money in hand. So the AD will reduce and shift towards left.

(c) AD curve cannot be steep at the time of change in money supply. It will either shift to left or right depending upon money supply decrease or increase.

(d) Similarly it cannot get flat with change in the money supply. Flat AD curve is not the result of RBA efforts to stabilise inflation but because of components of AD.