Question 2 [14 marks] Suppose the Australian money supply (M) grows at 4% in 2021, real GDP (Y) grows at 2%, the real interest rate (r) is -1%, and the money demand function is as follows. (M/P)4 = 0.7Y Based on the above information, answer the following questions. (a) Calculate the nominal interest rate (i), assuming the quantity theory of money holds. (3 marks) (b) Suppose the Reserve Bank of Australia (RBA) announces it will tighten its monetary policy in 2022, resulting in the Australian public expecting inflation to change to 1%. Assuming the nominal interest rate unchanged at the 2021 level, what is the ex-ante real interest rate in 2022? (1 mark) (c) Assume the Fisher effect holds, and the real interest rate remains constant at the 2021 level. If expected inflation for 2023 is 2%, what will the nominal exchange rate be in 2023? Motivate your answer. (2 marks) (d) What is the interpretation of the parameter value of 0.7 in the money demand function? (1 mark) (e) Calculate the velocity of money (V) based on the relationship between V and the parameter in part (d) up to one decimal value. (1 mark) (1) Suppose the RBA increases the money supply. Use an AD-AS diagram to illustrate both the short-run and long-run effects on price and real output. (4 marks) (9) Explain why your diagram in (f) aligns with the quantity theory of money and the concept of money neutrality. (2 marks) Question 2 [14 marks] Suppose the Australian money supply (M) grows at 4% in 2021, real GDP (Y) grows at 2%, the real interest rate (r) is -1%, and the money demand function is as follows. (M/P)4 = 0.7Y Based on the above information, answer the following questions. (a) Calculate the nominal interest rate (i), assuming the quantity theory of money holds. (3 marks) (b) Suppose the Reserve Bank of Australia (RBA) announces it will tighten its monetary policy in 2022, resulting in the Australian public expecting inflation to change to 1%. Assuming the nominal interest rate unchanged at the 2021 level, what is the ex-ante real interest rate in 2022? (1 mark) (c) Assume the Fisher effect holds, and the real interest rate remains constant at the 2021 level. If expected inflation for 2023 is 2%, what will the nominal exchange rate be in 2023? Motivate your answer. (2 marks) (d) What is the interpretation of the parameter value of 0.7 in the money demand function? (1 mark) (e) Calculate the velocity of money (V) based on the relationship between V and the parameter in part (d) up to one decimal value. (1 mark) (1) Suppose the RBA increases the money supply. Use an AD-AS diagram to illustrate both the short-run and long-run effects on price and real output. (4 marks) (9) Explain why your diagram in (f) aligns with the quantity theory of money and the concept of money neutrality. (2 marks)
