Question

Part 3

Imagine that the economy is experiencing inflation and that the Reserve Bank of Australia (RBA) decides to implement a contractionary monetary policy or 'tight money' to return inflation to its target level.

a) What type of open market operations (OMOs) will the RBA undertake consistent with a contractionary monetary policy approach?

b) How will the money supply be affected?

c) Explain how the three stages of transmission process from a contractionary monetary policy link a change in interest rates with a change in an economy’s equilbrium level of output.

d) Using the IS-LM curve diagram, illustrate the impact of a contractionary monetary policy. Make sure to clearly indicate the new equilibrium position including the interest rate and output level.

At the end of your answer to Part 3 state the word count for sub-part c. Your answer to Part 3 sub part c should not exceed 100 words. (Note: answers to sub-parts a and b while written should be no longer than 1 sentence each and hence are excluded from the word count requirement).

Can you give the prefences as well for the answer?

Answer 1

ans a RBA will use contractionary open market operations, that is it will SELLi ts securities in open market , which will bring inflation on equilibrium.

ans b it will reduce money supply , as commercial banks cash reserves and volume of credit availability will reduce

ans c transmission process

1 contractionary open market operations will decrease the bonds prices , which will increase interest rates.

2 rise in interest ratewill reduce capital investment.

3 as investment falls , income level falls as well as output level falls causing fall in demand and controls inflation

ans d when there is contractionary monetary policy then it will shifts LM curve leftwards, no effect on IS curve . but IS curve moves upwards , new equilibrium is formed at E1 where LM1=IS , as a result interest rates fron Ro to R1 and output level falls from Yo to Y1 (as shown in diagram)