Reserve bank??

Question

pls tell me if this statement is true, false or ambiguous and why..please explain..the better explainitions wil get more points..tnx

On a diagram with r on the vertical axis and π on the horizontal axis, the Reserve Bank’s

reaction function necessarily shifts whenever it increases the interest rate in response to

higher inflation.

Answer 1

The normal answer is that the statement is False because the reaction function gives the interest rate r that the Reserve Bank will choose to implement for any given inflation rate π. So, the Reserve Bank is operating along the reaction curve and there is no reason for the reaction curve to shift.when it chooses a particular interest.. But the reaction function can shift: it depend on the way the reaction function is constructed. If it is simply a relationship between actual inflation rate and the desired interest for inflation control or for defation control, the reaction curve cannot shift. But if the reaction function involes other variables or parameters like the the difference between expected inflation and actual inflation rates and the reserve requirement or the extent of surplus liquidity in the banking system. the reaction can shift after a change in the interest rate since inflationary expectations can alter the expected inflation rate and the surplus liquidity in the system may change especially if an increase in interest rate also accompanies a hike in the reserve requirement.

Answer 2

"False" - because reaction on higher inflation will be movement along reaction curve instead of shifting this curve.