The Money

Market 13
Multiple Choice
1 B 6 A* 11 D
2 A* 7 B 12 A
3 B 8 D* 13 C
4 C 9 B 14 C
5 A 10 D 15 B
*Indicates that an enhanced answer has been provided in the section below.

Enhanced Answers
2 A Yael is not holding Bitcoin to make a transaction (transactionary motive) or for a future possible
transaction (precautionary motive). There is no such thing as capital motive. Yael is buying
Bitcoin because she believes it will rise in value (so that she can sell it), which reflects a
speculative motive.
6 A M3 = Currency + Bank deposits with the RBA + Bank deposits.
$163,000m = Currency + $12,000m + $135,000m
$163,000m = Currency + $147,000m
Therefore the value of currency = $16,000 million.
8 D Two $50 notes means Cassandra has $100. Depositing $100 for a year at an annual interest
rate of 2 per cent would give her $2 in interest. If Cassandra keeps the $100 in her wallet, she
will not receive the interest of $2.

Short Answers
Question 1

(a) M3 is equal to currency plus bank deposits held at the RBA plus all deposits held at banks.
This means that deposits held at banks = M3 minus currency minus bank deposits held at the
RBA. Using the information provided, this is equal to $275,000 − $100,000 − $72,000 =
$103,000 million. Note that deposits at non-bank financial institutions (NBFI) are not included
in M3.

(b) The different measures of money calculated by the RBA differ in the types of money that they
include. The `narrower’ measures of money, for example, base money, only include the most
liquid types that most fully exhibit the characteristics of money (for example, banknotes). The
broader measures of money such as broad money include less liquid forms of money. For
example, money in a term deposit account (included in M3 and broad money) that matures in
a year cannot easily be used to make a purchase now, so it is not as a good of a medium of
exchange as currency. This means that the different measures of money can provide unique
insights into the Australian economy. For example, the growth in base money may inform us
about the demand for highly liquid funds.

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 The Market Economy Eighth Edition Workbook Chapter 13: The Money Market

(c) In the technical economic sense of the word, money has four characteristics. Cryptocurrencies
such as Bitcoin may meet some of those four characteristics. For instance, some
cryptocurrencies can be used as a medium of exchange since they can be used to purchase
goods and services from vendors that choose to accept them. However, the value of
cryptocurrencies can be extremely volatile. This means that many cryptocurrencies are not
very good stores of value since the value of a fixed holding can change rapidly. It is also
doubtful whether cryptocurrencies are a good measure of value because most prices in the
economy are expressed using Australian dollars only. Finally, there is currently limited or no
scope to borrow and lend money using anything other than dollars (so cryptocurrencies are
not an established method for deferring payment). Overall cryptocurrencies do not have the
four characteristics that constitute money.

(d) A decrease in global interest rates relative to domestic interest rates would make the returns
on domestic investments more attractive compared to other economies. Domestic lenders
would seek to bring their money back to Australia to take advantage of the better returns, thus
increasing the domestic money supply and the supply of loanable funds domestically. This
would put downward pressure on domestic interest rates.

Question 2

(a) Purchases or sales of new securities are never settled using banks’ balances in their exchange
settlement accounts and they do not influence monetary policy. The aim of domestic market
operations is to determine the cash rate in the overnight money market by influencing
exchange settlement account balances through trading existing government securities that
have already been issued.

(b) One reason why the size of a bank’s exchange settlement account may change is expectations
of future net inflows or outflows on the account. If a bank expects to have a large net outflow
of funds on a particular day, they will increase the size of their exchange settlement accounts.
A second reason is transactions paid by cheque occurring between customers of different
banks. For example, when a customer of the Commonwealth Bank uses a cheque to buy a
good from a business that has a bank account at ANZ, funds will flow from the Commonwealth
Bank’s exchange settlement account to ANZ’s exchange settlement account.

(c) To decrease the cash rate in the short-term money market, the RBA would purchase securities
(such as second-hand Commonwealth Government Bonds or Repurchase Agreements) from
financial institutions in the overnight money market. The RBA buys securities, for example,
from a bank or financial institution, by depositing money into the seller’s exchange settlement
account, creating a surplus of borrowable funds and leading to an increase in the supply of
settlement funds. This places upward pressure on the overnight cash rate.

(d) Provided banks pass on changes in the cash rate, an increase in the cash rate will lead to an
increase in the general level of market interest rates. This will lead to a decrease in the level
of economic activity. Higher interest rates discourage household consumption since the size
of existing mortgage repayments on variable mortgages will increase with higher rates (this
reduces the amount of income left for consumption), and the cost of new borrowing is
relatively higher. Further, business investment will decrease as borrowing funds for expansion,
capital equipment or hiring more staff is relatively more expensive.

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 The Market Economy Eighth Edition Workbook Chapter 13: The Money Market

Question 3

(a) Liquidity refers to the ease with which a financial asset can be converted into currency so that
it can be used as a medium of exchange.

(b) Household debt as a proportion household disposable income increased rapidly in the period
from the mid-1990s to the mid-2000s. Whilst household debt slowed in period immediately
after the global financial crisis in 2008 and 2009, it has picked up again in more recent years.

(c) The low level of interest rates over the past two decades has contributed to high household
debt. Low interest rates make it easier for households to borrow money more easily, leading
to an increase in consumption and investment while also making the purchase of new family
homes more accessible. Secondly, higher house prices mean people have to borrow much
more money in order to buy a house or apartment. Thirdly, growth in negatively-geared
property investments have contributed to higher household debt.

(d) The government can indirectly influence interest rates by participating in financial markets as
either a borrower or lender. This will affect the overall demand or supply of funds in these
markets and therefore can put upward or downward pressure on interest rates. For instance,
in order to stimulate economic activity during downturns by increasing spending or reducing
taxes, the government may borrow money if it makes the budget go into deficit (or increases
the size of a current deficit). This would increase the demand for funds and put upward
pressure on interest rates.

(e) There are three main motives affecting an individual’s demand for money. Firstly, the
transactions motive. Individuals need to hold a certain quantity of money (either paper
currency or electronic money) for carrying out day-to-day transactions for which they require
liquid funds. Secondly, the precautionary motive. People often hold money so that they are
able to better deal with unpredictable circumstances or emergencies. Thirdly, the speculative
motive. As part of their investment portfolio, individuals may hold a certain quantity of funds
in the form of money rather than risk making capital losses by investing in financial assets.

Skills Revision Activity 1

To INCREASE To REDUCE
Economic activity Economic activity

Tightening/loosening monetary policy Loosen Tighten

Sell/buy securities Buy Sell

Impact on borrowable funds (ESA) Increase Decrease

Cash rate Decrease Increase

Market interest rates Decrease Increase

Cost of borrowing Decrease Increase

Consumption and investment Increase Decrease

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 The Market Economy Eighth Edition Workbook Chapter 13: The Money Market

Skills Revision Activity 2 – Cash Rate

Tightening
Change to ESA: Decrease
Change to Money Supply: Decrease
Diagram: Show a leftward shift in the vertical money supply (MS) curve and an increase in the cash rate.
Change to the cash rate: Increase

Loosening
Change to ESA: Increase
Change to Money Supply: Increase
Diagram: Show a rightward shift in the vertical money supply (MS) curve and a decrease in the cash rate.
Change to the cash rate: Decrease

Skills Revision Activity 3

Demand/supply Increase/decrease

BHP Billiton decides to open a new mine in WA Demand Increase

The household savings ratio increases by ten per cent Supply Increase

The Commonwealth budget deficit decreases from

Demand Decrease
$40 billion to zero

An Australian furniture manufacturer responds to a

downturn in economic activity by cutting back Demand Decrease
investment in new machinery

The government increases the income tax free

Demand Increase
threshold, leading to increased consumption

Uncertainty in the global economy reduces foreign

Supply Decrease
investment in Australia

The government increases the level of compulsory

Supply Increase
superannuation contributions by employers

Overseas interest rates increase relative to Australian

Supply Decrease
interest rates

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