Part 3

Imagine that the economy is experiencing inflation and that the Reserve Bank of Australia (RBA) decides to implement a contractionary monetary policy or 'tight money' to return inflation to its target level.

a)What type of open market operations (OMOs) will the RBA undertake consistent with a contractionary monetary policy approach?

b)How will the money supply be affected?

c)Explain how the three stages of transmission process from a contractionary monetary policy link a change in interest rates with a change in an economy's equilibrium level of output.

d)Using the IS-LM curve diagram, illustrate the impact of a contractionary monetary policy. Make sure to clearly indicate the new equilibrium position including the interest rate and outputlevel.