Question

(i) Explain the difference between the nominal and real interest rate. (ii) How does the Reserve Bank of Australia control the interest rate? (iii) You hear a news report that output growth and inflation are lower than expected. How do you expect that report to affect market interest rates? Explain why. (iv) The Reserve Bank faces a large recessionary gap. How would you expect it to respond? Explain step by step how its policy change is likely to affect the economy. Use the AD-AS diagram to illustrate your answer.

Under a flexible exchange rate regime, how does an easing of monetary policy (a lower interest rate) affect the value of the exchange rate? Explain how this change of policy affects output and employment.

Under a flexible exchange rate regime, how does an easing of monetary policy (a lower interest rate) affect the value of the exchange rate? Explain how this change of policy affects output and employment.

Answer 1

i) A real interest rate is an interest rate that has been changed in accordance with evacuate the impacts of inflation to the borrower and the genuine respect the bank or to a financial specialist. A nominal interest rate alludes to the interest rate because of inflation before considering.

Formula= nominal interest rate = real interest rate + inflation rate

(ii) How does the Reserve Bank of Australia control the interest rate?

Answer: Reserve Bank of Australia controls the interest rate by two methods: fiscal policy and monetary policy

Fiscal policy:

a) Government expenditure:By changing any or all types of government expenditure government seeks to control the interest rate.

b)Changing the tax burden from the citizens.
c) Public borrowing is another component to control the interest rate.

Monetary policy:

a) Changing repo rate/bank rate

b) Open market operations where buying and selling of securities take place

c) Controlling the fluctuation the CRR and SLR.

d) Changing margin requirement and notions of credit rationing

iii) You hear a news report that output growth and inflation are lower than expected. How do you expect that report to affect market interest rates?

Answer: Estimated Nominal interest rate will be lower than the real interest rate since inflation rate is lower than estimated. Economy will slow down as the aggregate demand, employment rate, inflation fell.

(iv) The Reserve Bank faces a large recessionary gap. How would you expect it to respond? Explain step by step how its policy change is likely to affect the economy. Use the AD-AS diagram to illustrate your answer.

Answer: For recessionary gap, The Reserve Bank will respond in the following ways:

a) Repo rate is lowered, following which market interest is reduced. Accordingly, demand for credit will increase to correct the recessionary gap.

b) Securities are purchased by the Reserve Bank in the open market to inject liquidity in the system. This raised aggregate demand.

c) CRR and SLR are lowered. This raises capacity of the commercial banks to create credit. Accordingly borrowing rises causing an increase in aggregate demand.

d) Margin requirement is reduced. This makes credit more attractive.

e) Moral pressure is exerted by the reserve bank on the commercial banks to be liberal in lending, so that demand for credit increases and AD is raised.

f) Credit rationing is withdrawn. Availability of credit becomes easy. Accordingly aggregate demand rises since borrowing gets raised.

For diagram, refer to the image.

Under a flexible exchange rate regime, how does an easing of monetary policy (a lower interest rate) affect the value of the exchange rate? Explain how this change of policy affects output and employment.

question) Under a flexible exchange rate regime, how does an easing of monetary policy (a lower interest rate) affect the value of the exchange rate? Explain how this change of policy affects output and employment.

Answer: Easing monetary policy will cause the exchange rate will rise under a flexible exchange rate regime, since by lowering interest rate the money supply in the economy will rise.

The output growth rate and employment rate will consequently rise as because by lowering interest rate, borrowing will rise which will force the aggregate demand to rise implying that there will be a simultaneous rise in output and employment.

Expendihoro ADF ADu 439 पoजक ंटরन Tn cone Tndex Deficeat Deman Recessinary 9ap o n1 ADE -ADU- Gk )ADĻE Euipaplayment Aagat Demand AD Scanned with Undlanempioyant AD C$ CamScanner Aggragat Demand