Tutorial assignment: week 4 2022
Answer guide
1. Using information from the RBA web site, identify two periods in this century when the
rate of growth of the Currency aggregate in Australia exceeded 10 per cent. What were the
significant events in these periods that might explain higher than normal growth in
Currency?
There are two places in the RBA site where this information can be readily found.
In graphical form, this information is presented in the RBA chart pack [navigating from home
page: Chart Pack>>Credit and Money>>Monetary Aggregates Growth] to find the following
graph (which was also presented in the lecture):
In numerical form, figures for the level of currency (but not the growth rate) can be found in
the Statistics section of the site in Table D3, column B [Statistics>>Economic and Financial
Statistics>>Monetary Aggregates – D3]. You would need to calculate percentage changes in
these figures to answer the question.
Using the graph above, we can easily read off an answer to the first part of the question. Currency
growth exceeded a 10 per cent annual rate in 2008-9 and again in 2020-21. Significant events that
could explain these high rates of currency growth:
2008-9: the GFC. During this period there was a lot of uncertainty about economic prospects
as the world economy went into recession, banks failed and the value of many investments
such as equities was falling. In these sorts of conditions, households tend to prefer the safety
of cash and will try to hold a larger proportion of their wealth in that form. At the same time,
governments in Australia and abroad were making cash more readily available to households
and businesses through stimulus payments to counteract the effects of the GFC. In Australia
for example there were cash payments of $950 made to taxpayers in February 2009. These
would have been paid into bank accounts, but to the extent that they were withdrawn and
, spent as cash, they would have added to currency growth. Similar policy actions were being
taken in other economies.
2020-21: this was another time of major uncertainty due to the pandemic. Again, because of
the uncertainties householders preferred to hold a larger proportion of their financial wealth
in cash, and the government again was making significant payments to households and
businesses to support the economy and alleviate financial stress.
2. During the first of the periods identified above, what was happening to the growth of M3?
What factors might explain an increase in Currency growth and a slowing in M3 growth
occurring at the same time?
The growth of M3 was decelerating sharply during that period (see graph).
While the growth rates of the different monetary aggregates can often differ by significant amounts,
it is unusual for their growth rates to move sharply in opposite directions. When this happens, it is
likely to signify some event that is having a major impact on the relative attractiveness of bank
deposits compared to currency. (This didn’t happen, for example, in the 2020-21 episode.)
In the 2007-9 period, while currency growth was increasing, the annual growth rate of M3 slowed
down from nearly 25 per cent to less than 15 per cent by 2008, and continued to slow down over the
following year. The fact that these two growth rates were moving in opposite directions for a period
of time can be explained by the nature of the financial crisis that was occurring. The M3 aggregate is
equal to Currency plus bank deposits. During this period, people were losing confidence in the safety
of banks. Some were withdrawing funds from bank deposits in order to build up their cash holdings.
Others may have chosen to increase their bank deposits more slowly than previously in order to
increase cash holdings more quickly. So the two growth rates were moving in opposite directions. As
confidence in the banks was restored over the following two years, the rates of growth of the two
aggregates again converged.
3. The phenomenon of ‘dollarisation’ in an economy is said to occur when a significant
proportion of residents prefer to make their transactions in US dollars rather than in the
official domestic currency. Why might this occur, and why would this phenomenon be
more common in some countries than in others?
One of the functions of money is store of value. This requires money to have a stable and
predictable purchasing power. In other words, it requires an economy with low and stable inflation
of prices expressed in that currency. Dollarisation typically occurs in economies that have either high
inflation, or a high fear of inflation.
If money is unable to perform the store of value function efficiently, this will also undermine the
other functions of money, especially the medium of exchange function. One of the desirable
characteristics of a medium of exchange is that money must be widely accepted. But if it is not
expected to maintain a stable value, no one will want to hold it and so it won’t be widely accepted as
a means of payment. These things reinforce each other.
Answer guide
1. Using information from the RBA web site, identify two periods in this century when the
rate of growth of the Currency aggregate in Australia exceeded 10 per cent. What were the
significant events in these periods that might explain higher than normal growth in
Currency?
There are two places in the RBA site where this information can be readily found.
In graphical form, this information is presented in the RBA chart pack [navigating from home
page: Chart Pack>>Credit and Money>>Monetary Aggregates Growth] to find the following
graph (which was also presented in the lecture):
In numerical form, figures for the level of currency (but not the growth rate) can be found in
the Statistics section of the site in Table D3, column B [Statistics>>Economic and Financial
Statistics>>Monetary Aggregates – D3]. You would need to calculate percentage changes in
these figures to answer the question.
Using the graph above, we can easily read off an answer to the first part of the question. Currency
growth exceeded a 10 per cent annual rate in 2008-9 and again in 2020-21. Significant events that
could explain these high rates of currency growth:
2008-9: the GFC. During this period there was a lot of uncertainty about economic prospects
as the world economy went into recession, banks failed and the value of many investments
such as equities was falling. In these sorts of conditions, households tend to prefer the safety
of cash and will try to hold a larger proportion of their wealth in that form. At the same time,
governments in Australia and abroad were making cash more readily available to households
and businesses through stimulus payments to counteract the effects of the GFC. In Australia
for example there were cash payments of $950 made to taxpayers in February 2009. These
would have been paid into bank accounts, but to the extent that they were withdrawn and
, spent as cash, they would have added to currency growth. Similar policy actions were being
taken in other economies.
2020-21: this was another time of major uncertainty due to the pandemic. Again, because of
the uncertainties householders preferred to hold a larger proportion of their financial wealth
in cash, and the government again was making significant payments to households and
businesses to support the economy and alleviate financial stress.
2. During the first of the periods identified above, what was happening to the growth of M3?
What factors might explain an increase in Currency growth and a slowing in M3 growth
occurring at the same time?
The growth of M3 was decelerating sharply during that period (see graph).
While the growth rates of the different monetary aggregates can often differ by significant amounts,
it is unusual for their growth rates to move sharply in opposite directions. When this happens, it is
likely to signify some event that is having a major impact on the relative attractiveness of bank
deposits compared to currency. (This didn’t happen, for example, in the 2020-21 episode.)
In the 2007-9 period, while currency growth was increasing, the annual growth rate of M3 slowed
down from nearly 25 per cent to less than 15 per cent by 2008, and continued to slow down over the
following year. The fact that these two growth rates were moving in opposite directions for a period
of time can be explained by the nature of the financial crisis that was occurring. The M3 aggregate is
equal to Currency plus bank deposits. During this period, people were losing confidence in the safety
of banks. Some were withdrawing funds from bank deposits in order to build up their cash holdings.
Others may have chosen to increase their bank deposits more slowly than previously in order to
increase cash holdings more quickly. So the two growth rates were moving in opposite directions. As
confidence in the banks was restored over the following two years, the rates of growth of the two
aggregates again converged.
3. The phenomenon of ‘dollarisation’ in an economy is said to occur when a significant
proportion of residents prefer to make their transactions in US dollars rather than in the
official domestic currency. Why might this occur, and why would this phenomenon be
more common in some countries than in others?
One of the functions of money is store of value. This requires money to have a stable and
predictable purchasing power. In other words, it requires an economy with low and stable inflation
of prices expressed in that currency. Dollarisation typically occurs in economies that have either high
inflation, or a high fear of inflation.
If money is unable to perform the store of value function efficiently, this will also undermine the
other functions of money, especially the medium of exchange function. One of the desirable
characteristics of a medium of exchange is that money must be widely accepted. But if it is not
expected to maintain a stable value, no one will want to hold it and so it won’t be widely accepted as
a means of payment. These things reinforce each other.
