Monetary policy and the RBA

  1. Suppose a newspaper headline read: ‘Companies invest as interest rates reach
    a 20-year low’. Explain the connection between this headline and the monetary
    policy pursued by the RBA during that time. How might firms’ expectations that
    the rates of return on new investments are too low make monetary policy less
    effective in ending a recession?
  2. Use the following graph to answer these questions.
    a If the RBA does not take any policy action what will be the level of real GDP
    and the price level in year 2?
    b If the RBA wants to keep real GDP at its potential level in year 2, should it
    use an expansionary policy or a contractionary policy? Should the RBA be
    buying financial securities or selling them?
    c If the RBA takes no policy action what will be the inflation rate in year 2? If
    the RBA uses monetary policy to keep real GDP at its full-employment level,
    what will be the inflation rate in year 2?
  3. For many years now, the RBA has used the cash rate as its monetary policy
    target. Why doesn’t it target the money supply at the same time? What are the
    main arguments used to support inflation targeting? What are the main
    arguments against inflation targeting?
    a. Do you think that inflationary targeting has introduced an economic
    environment that is more conducive or less conducive to investment and
    economic growth? Explain your answer.
    b. In what ways is the RBA more independent of the federal government than
    other institutions like, for instance, the Federal Treasury?
    a. What arguments do economists make in support of the independence of the RBA
    and what arguments are used against the independence of the RBA?
    b. Do you think that the RBA is truly independent of the government in its
    determination of monetary policy? Provide evidence for your answer.

Sample Solution