Consider an economy that is operating at its potential GDP (that is, GDP is on trend) and the inflation rate is equal to the target rate. Suppose there is a shock to Australian imports; specifically, Australian consumers increase their imports of Chinese manufactured goods as they are perceived to have even greater value than before while at the same time maintaining their imports from other countries.

(c) In the market for interbank loans (the 'cash' market), is the interest rate bounded? If it is, explain why and if it is not, explain why not.

(d) If the target cash rate is 2% and the equilibrium cash rate is 2.1% what would the RBA do?