On the 7th February 1996 the RBA cash rate target was 7.50%.

(a) Draw a very detailed, complete and to scale market for reserves to reflect that situation of the 7th February 1996. Assume that the cash rate is on target.

In the same diagram, represent with a blue arrow the magnitude of the corridor for the cash rate and with a red arrow the largest distance the cash rate could be away from the target. [If you do not have blue and red pens use <-----> instead of blue and <===> instead of red.]

(b) Assume that the equilibrium cash rate would be at 7% in the absence of any RBA interventions. Represent this situation in a new diagram. From a cash rate targeting perspective, describe the issue of this situation.

(c) Explain in words only how the RBA would sort out the issue described in (b).