Question 1: (Word limit 500).
The inflation target of the Reserve Bank of Australia (RBA) is 1~3%. Suppose now the inflation is going up quickly and will be higher than this target soon. Moreover, the strong Australian dollar has started to hurt the Australian export. Please use what you have learnt from this unit to discuss whether it’s possible for the RBA to keep the inflation within the target and also to depreciate the Australian dollar. [10 marks]
Through utilizing inflation targeting, the RBA will usually raise interest rates if inflation appears to be above the target range of 1-3% in hopes of decreasing the inflation rate. The raised interest rates will then decrease the ...view middle of the document...
In the meantime, a greater money growth stimulates aggregate demand in Australia, due to lower interest rates which shifts price level to the right/upwards. As such, an expansionist monetary policy would depreciate the Australian dollar while increasing inflation.
Nevertheless, a depreciating Australian dollar does not necessarily cause inflation. Variables that affect the dollar value and inflation do not necessarily cause an inverse relationship between the two.
The RBA may utilize Contractionary fiscal policy to shift both the dollar value and inflation rate down. As the budget deficit lowers or if the government were to experience a budget surplus, local interest rate will decrease relative to foreign interest rates. Thus, the Australian dollar assets will become decreasingly attractive to investors in comparison with foreign assets, leading to a decreased demand for Australian dollar, which results in an depreciating dollar. In the meantime, a budget surplus lowers aggregate demand in Australia, exerting a downwards pressure on Australian prices. As such, a contractionary fiscal policy leads to a decrease in both the Australian dollar and inflation.
Question 2: (Word limit 1000).
In 2011, Japan was hit by a powerful earthquake. Using the tools that you have learned from this course, describe
a) how the Japanese yen moves (depreciation or appreciation against Australian dollar) and why; and what Japanese central bank can do to handle this crisis and how it will affect Japanese money market and foreign exchange market; [Hint: check what Japanese central bank did after the 1995 Kobe earthquake. You may use it as an example to support your analysis]; [5 marks]
Although theoretically, in the short term the Japanese yen should have depreciated in the wake of the earthquake due to an undesirable supply shock and decreased confidence due to predicted economic damage, which in turn would influence investors to remove yen assets to safer foreign currencies in order to minimize economic loss. This intern results in the depreciation of the yen as the money supply increases to purchase the assets sold, leading to decreased demand for the Japanese yen. thus ensuring that foreign currencies will generally appreciate relative...