1) You have decided to deposit $2,000 in a savings account in the Commonwealth Bank, which does not have any excess reserves at the time when you make a deposit.
a) How does your deposit change the Bank's T-account? Show the T-account changes.
b) Now the Bank is told to maintain a reserve ratio of 0.2 (ie, 20 percent). The Bank decides to make the maximum possible loan from the deposited funds. Following from the T-account in Part a), what does the T-account look like now?
c) Now, somebody who took out the loan in Part b) writes a cheque for the amount and then the person receiving the cheque deposits it in WestPac Bank which also maintains a reserve ratio of 0.2. Show how this changes the T-account of WestPac Bank.
d) If the process of money creation continues what is the total money supply resulting from your initial $2,000 deposit?
2) Suppose that the price level in Australia is expected to rise by 7% in 2016.
a) Why do some economists claim that we should not worry too much about inflation at this level?
b) Other economists think that there are significant costs associated with inflation above 2-3%. What are they?
c) What are the other costs be to consider if the inflation rate unexpectedly turns out to be higher than 7%?
3) Consider an economy that is initially in long run equilibrium in the AD-AS diagram as shown in Figure below. Use the Figure to demonstrate the following changes.
a) Suppose people in the economy start to become a bit worry about the future of the economy and decided to save more. This translates into an increase in private saving (we assume that this happens given any real interest rate and price level).
i. How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrate it in AD-AS diagram below
ii. On the same diagram illustrate the adjustment process to long run equilibrium (assuming that real potential output remains unchanged, so no change in LRAS), and explain the final impact on the price level.
b) Suppose many Australian firms mistakenly expect that there will be an increase in the relative price of their own products as compared to others (including relative to the input costs and wages they pay). This should shift the SRAS curve. Start with the equilibrium point shown in the Figure below and use it to demonstrate the following changes.
i. How does this change the aggregate price level, real income and unemployment in the short run? Explain and illustrate in the AD-AS diagram
ii. On the same diagram illustrate the adjustment process to long run equilibrium (assuming that real potential output remains unchanged, so no change in LRAS), and explain the final impact on the price level.
4) Read the article from the Age which starts "Don't waste any time worrying about it: Australia is heading into a recession..."
The author argues that the Australian economy is inevitably heading into recession. What reasons does he give for this and do you agree with them? Supposing the economy is heading for recession what in your view should (or can) the Australian government do to deal with this? You need to write at least half a page in length.