Question 1: (Word limit 500). The Reserve Bank of Australia's (RBA) inflation target is 1~3%. Now suppose that inflation is rising rapidly and will soon be above this target. Additionally, the strong Australian dollar has started to hurt Australian exports. Please use what you have learned in this unit to discuss whether it is possible for the RBA to keep inflation within target and also depreciate the Australian dollar. [10 marks] Through the use of inflation targeting, the RBA typically raises interest rates if inflation appears to be above the target range of 1-3%, in the hope of reducing the inflation rate. Increased interest rates will therefore reduce the demand for money due to the increased opportunity cost of holding monetary assets. The price level and value of the dollar could be affected by a combination of monetary and fiscal policy. These factors, more often than not, would move the dollar and the price in opposite directions. Keeping in mind that real exchange rates adjust to differences in local and foreign price levels are constant. An expansionary monetary policy where the RBA increases the money supply (M) can cause prices (P) to rise. While an increase in the money supply would likely lead to a decline in the dollar exchange rate (E). When the dollar depreciates, more than the price increases, the real exchange rate (R) decreases and the price level increases. can conclude that a decline in the real exchange rate independently translates into an increase in the price level. If the RBA wishes to devalue the Australian dollar, it can do so through expansionary monetary policy. As the money supply increases and Australian interest rates fall (chart) relative to their foreign counterparts. T...... middle of paper ......the earthquake for the Japanese market. This could be attributed to the economic uncertainty of the affected regions in addition to the production disorder of the affected regions. However, after implementing expansionary monetary policies, the Japanese government will try to restore and reorganize the damaged regions. As a result, coupled with falling interest rates that would stimulate demand, Australian exports would increase due to increased demand for raw materials. Increased exports to Japan will result in an increase in Australia's gross national product and gross domestic product. Furthermore, increased exports can lead to a surplus of exports over imports, resulting in an increase in net foreign wealth. The Australian currency would also appreciate due to the Japanese Federal Bank's increased purchases of Australian dollar-based assets.