Q2. Consider a simple but sophisticated monetary system in which all credit is provided by banks and where there is no c

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Q2 Consider A Simple But Sophisticated Monetary System In Which All Credit Is Provided By Banks And Where There Is No C 1 (127.76 KiB) Viewed 68 times

Q2. Consider a simple but sophisticated monetary system in which all credit is provided by banks and where there is no cash such that all transactions are expedited by way of bank deposit transfers (i.e. EFTPOS). The assets of the banks consist wholly of bank loans to the private sector. Now suppose the central bank has an inflation target of 3% and the inflation rate increases to 5%. Also suppose the current target cash rate set by the central bank is 1% and it is estimated that for every increase of 1% in the cash rate and, therefore, interest rates in general, the demand for loans in the economy declines by $180 billion per annum. a. Assuming the banks' reserve ratio, r, is 10%, and annual demand for loans is $1800 billion, determine both the current annual amount of bank loans, deposit money and reserves (or liquid funds) and their annual amounts in the year after the central bank raises the cash rate to 4% to arrest the increase in the inflation rate. (3 marks) b. Explain the transmission process of this restrictive monetary policy by the central bank associated with the endogenous contraction in money and credit creation in less than 200 words. (4 marks)