VCE-ECON-U34 E2.1 Practice Exam 2: Question Paper

A) Adjusting the rate of income tax
B) Setting the target cash rate (the overnight interest rate in the interbank lending market) to influence the cost of borrowing across the economy
C) Buying and selling government bonds to directly control money supply
D) Setting the exchange rate

A) 0-1% per annum
B) 2-3% per annum (on average over the medium term)
C) 4-5% per annum
D) Below 2% per annum in every quarter

A) Higher household spending and investment
B) Higher cost of borrowing → reduced household consumption and business investment → lower aggregate demand → reduced inflationary pressure
C) Higher employment
D) Lower exchange rate

A) The management of the exchange rate
B) Government decisions about spending and taxation — used to influence aggregate demand and the distribution of income
C) The RBA’s management of interest rates
D) The government’s regulation of financial markets

A) Increasing taxes and reducing government spending
B) Reducing taxes and/or increasing government spending to stimulate aggregate demand
C) Reducing the money supply
D) Raising interest rates

A) Discretionary government spending increases during a recession
B) Income tax (which falls automatically in recession) and unemployment benefits (which rise automatically in recession) — reducing the severity of economic fluctuations without explicit policy decisions
C) Changes in the cash rate
D) Infrastructure spending programs

A) Government spending is always wasteful
B) An initial change in government spending or taxation leads to a larger final change in GDP — because initial spending becomes income for others who then spend a proportion of it
C) Tax cuts always stimulate more growth than spending increases
D) Government deficits reduce private investment

A) The physical transmission of money through the banking system
B) The channels through which a change in the cash rate affects inflation and economic activity — including the interest rate channel, exchange rate channel, and asset price channel
C) The government’s communication of fiscal policy
D) The RBA’s communication strategy

A) Government reduces spending
B) Government borrowing to finance a deficit raises interest rates, crowding out private sector investment by making borrowing more expensive
C) Private firms reduce hiring
D) Tax cuts crowd out welfare spending

A) The accumulated total government debt
B) The difference between government revenue (taxes) and government expenditure in a given year — positive = surplus; negative = deficit
C) The ratio of debt to GDP
D) The total government spending as a proportion of GDP

A) Inflation is too high
B) The cash rate approaches the zero lower bound and conventional monetary policy loses effectiveness — the central bank buys financial assets to inject money into the economy
C) Government needs to finance its deficit
D) The exchange rate is too high

A) RBA sets mortgage rates directly
B) A rise in the cash rate → rises in market interest rates → higher borrowing costs → reduced business investment and household consumption → lower aggregate demand → lower inflation
C) A fall in cash rate increases the money supply directly
D) Higher cash rate → lower exchange rate → higher import prices → inflation

A) The shape of Australia’s current account
B) The phenomenon where a currency depreciation initially worsens the trade balance before improving it — because existing contracts are in old prices; adjustment takes time
C) The growth path of GDP after a recession
D) The relationship between interest rates and investment

A) Increase aggregate demand
B) Increase the productive capacity of the economy — shifting the aggregate supply curve right — through structural reforms, reducing regulatory burden, improving labour market flexibility, investing in human capital and infrastructure
C) Reduce the trade deficit
D) Reduce inflation by restricting the money supply

A) How long it takes to collect taxes
B) The delays between identifying an economic problem, deciding on a policy response, implementing the policy, and the policy taking effect — fiscal policy may act too slowly to stabilise the economy and may be pro-cyclical
C) Government’s delay in reporting GDP data
D) The time between budget announcement and implementation

A) The economy is at full employment
B) The economy is in recession — aggregate demand is deficient; government borrowing provides stimulus; automatic stabilisers also naturally create deficit in recession
C) Inflation is above the target
D) The exchange rate is falling

A) RBA sets the exchange rate directly
B) A rise in cash rate → higher Australian interest rates → foreign capital inflows → demand for AUD rises → AUD appreciates → exports more expensive → imports cheaper → reduces net exports → reduces AD
C) A fall in cash rate depreciates the currency → reduces inflation
D) Exchange rate movements are independent of the cash rate

A) Money has no effect on the economy
B) In the long run, changes in the money supply affect only the price level, not real output or employment — real variables are determined by real factors (technology, capital, labour)
C) Monetary policy always works perfectly
D) Fiscal policy is more effective than monetary policy

A) Australia borrows to finance government deficits only
B) Australia has a persistent current account deficit — domestic investment exceeds domestic savings — requiring borrowing from abroad; the accumulated debt creates interest obligations that reduce future income
C) Australia has no foreign assets
D) All developing countries have high foreign debt

A) The RBA sets its own objectives without accountability
B) An independent central bank can make unpopular decisions (raising interest rates before an election) that are necessary for long-run price stability without short-term political interference
C) The RBA must always raise rates before elections
D) Independent central banks are always more effective than government-controlled ones

Explain how a decrease in the cash rate by the RBA is expected to stimulate economic activity. Describe the main transmission channels.

Describe the difference between discretionary and automatic fiscal policy. Give examples of each in the Australian context.

Explain the concept of the fiscal multiplier. What factors affect its size?

Explain what is meant by the ‘zero lower bound’ problem for monetary policy and how central banks have responded.

What is Australia’s structural budget position and how does it differ from the cyclical budget position?

Describe the concept of the output gap and explain how it guides monetary and fiscal policy decisions.

Evaluate the use of fiscal policy versus monetary policy for macroeconomic stabilisation in Australia.

Explain how the RBA’s monetary policy decisions affect the housing market in Australia.

Extended Response 1: Monetary Policy

Extended Response 1: Monetary Policy (a)
Assess the effectiveness of the RBA’s monetary policy in achieving its goals over the period 2020-2024.

Extended Response 1: Monetary Policy

Extended Response 1: Monetary Policy (b)
Explain the limitations of monetary policy in addressing Australia’s structural economic challenges.

Extended Response 2: Fiscal Policy

Extended Response 2: Fiscal Policy (a)
Evaluate the Australian government’s fiscal policy response to the COVID-19 recession (2020-2021). Was it appropriate in scale, design and timing?

Extended Response 2: Fiscal Policy

Extended Response 2: Fiscal Policy (b)
Should the Australian government aim to achieve a budget surplus as soon as possible? Evaluate the fiscal management framework.