"The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2-3 per cent, on average, over time. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations."

a) A typical Australian Bank offers short term loans for 9%. Calculate

1.the expected real interest rate for a typical consumer.

2.the expected real interest rate for a typical business owner.

b) Australian households have very high debt to income ratios. Business Investments is sluggish. Use your results from a) to explain these facts.

c) For 45 months, the inflation rate has been below the RBA's target. Explain briefly the "textbook solution" to increase inflation, i.e. identify which kind of open market operation the RBA should do.

d) Use your answers for a) and b) to explain why the RBA might be reluctant to follow the textbook approach.