ECON 1102 Week 9

# A contractionary raise b contractionary lower c

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A. contractionary; raise B. contractionary lower C. contractionary; not change D. expansionary; raise

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11 11 Recap Week 8: The RBA fights inflation . 0 Y (= GDP) PAE (planned aggregate expenditure) PAE (r = 5%) 4,800 Y*= 4,600 PAE (r = 9%) An increase in r shifts PAE down
Recap Week 8: Reserve Bank actions that decrease nominal interest rates and increase the money supply: A. close a contractionary gap B. close an expansionary gap C. raise the policy reaction function D. lower the policy reaction function

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Recap Week 8: Modelling the behaviour of the RBA the Policy Reaction Function The RBA attempts to stabilise the economy by manipulating the real interest rate in response to the ‘output gap’ and the inflation rate A policy reaction function tries to explain/predict by how much the RBA changes the cash rate when there are changes in the state of the economy (eg ‘output gap’, ‘inflation rate’) THE TAYLOR RULE has been developed to describe the behaviour of the US Federal Reserve r = 0.01 0.5 [( Y* - Y)/Y *] + 0.5 => Suggests Federal Reserve responds to both output gaps and rate of inflation 13
Recap Week 8: According to the Taylor rule, the Reserve Bank lowers the real interest rate as the output gap ____ or the inflation rate ______. A. increases; increases B. increases; decreases C. increases; remains constant D. decreases; increases

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Unit 9: Inflation, Aggregate Supply and the Aggregate Demand-Aggregate Supply Model 1. Review 2. AS-AD Model a. Aggregate Demand b. Inflation and Aggregate Supply 3. Using the AS-AD Model whether or not to use stabilisation policies? 4. Controlling inflation Read: Bernanke Ch 9 15
16 Review: RBA policy reaction function simplifying assumption that RBA reacts only to inflation* Inflation ( ) real interest rate set by RBA ( r ) RBA’s policy reaction function 0.02 0.04 0.06 0.03 0.05 0 0.01 0.02 0.03 0.04 *Captures tendency to raise cash rate when economy is ‘overheati (expansionary gap) and reduce cash rate when economy is sluggish (recessionary gap) Movement along policy reaction function If change in r in response to change in

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