Question 1

Assume the Australian economy is originally at the long-run equilibrium.

Strong and sustained demands for iron ore, thermal coal and other minerals from China and India instigate a resource-driven boom in Australia, with the annualised inflation rate hitting 5%.

Required:

(a) Given the economic environment described above, do you recommend the Reserve Bank of Australia (RBA) to implement expansionary monetary policy or contractionary monetary policy? Clearly explainwhy.

(b) Clearly explain the steps the RBA has to undertake in order to implement the monetary policy stance recommended in (a).

(c) Clearly explainhoweach component of aggregate demand (AD) will be affected by the RBA's new monetary policy stance.

(d) Is monetary policy more effective in taming an overheated boom (expansion) OR in fighting a deepening slump (recession)? Clearly explainwhy.