How many policy lags should I memorise?

Two families are enough: inside lags (recognition and decision) and outside lags (effect), with one example each.

How does the liquidity trap relate to quantitative easing?

Precisely because rates have hit zero and conventional cuts no longer work, central banks buy assets through quantitative easing to press down long-term yields.

S6 Economics | Monetary Policy Practice Paper 3 (Challenge)

2026-11-04

Tutor Prep Guide · Secondary Economics

Focused on policy limits and the open economy: where the transmission chain breaks, the liquidity trap, capital flows driven by interest gaps, the cost of quantitative easing, the effective multiplier and policy lags.

Attempt first, mark afterwards　Allow about thirty-five minutes; for essay items list the three steps of tool, intermediate target and ultimate target, then write the limits, and the answer will read far better structured.

01　Paper details (check answers afterwards)

Item	Detail
Questions	10 items
Suggested time	About 35 minutes
Difficulty mix	Foundation 4 · Intermediate 3 · Challenge 2 · Error redo 1
Chapter	Chapter: S6 Economics \| Monetary Policy
Level	S6 (Secondary 6) Economics

02　Questions (10 items)

FoundationInterest rates are already near zero and the economy is still weak. Why does expansionary monetary policy often fail in this situation?
FoundationWhich sequence best describes the transmission of interest rate policy?
FoundationThe domestic interest rate rises while the foreign rate is unchanged, other things equal. What happens to the currency and to exports?
FoundationWhat does the central bank mean when it acts as lender of last resort?
IntermediateThe domestic rate is 5%% and the foreign rate 2%%, with risk and other conditions equal. What is the interest gap in percentage points, and where does capital tend to flow?
IntermediateWhat is quantitative easing, why can it still work when rates are near zero, and what risks does it carry?
IntermediateWho runs monetary policy and fiscal policy, and what tools does each use?
ChallengeInflation is 3% and the central bank wants a real rate of 1%. At about what level should it set the nominal policy rate?
ChallengeBanks hold 2,000 billion of deposits with a required reserve ratio of 10% (required reserves 200 billion) and voluntarily hold another 100 billion of excess reserves. What are the excess reserve ratio and the effective deposit multiplier, against a theoretical 10?
Error redoError review: a student claims that once the central bank raises rates, inflation will fall the following month. What is wrong with that?

03　Answers and one-line notes

#	Answer	One-line note
1	A liquidity trap: new money is held as idle cash and cannot push rates lower to stimulate investment	When rates cannot fall further, buying bonds merely swaps securities for cash inside the banking system while investment and spending stay put, so fiscal policy has to take over.
2	Policy rate cut leads to lower bank deposit and lending rates, then higher investment and consumption, then higher aggregate demand, then higher output and prices	Transmission has to travel the whole chain before it shows; if any link breaks, for example banks not lending or firms lacking confidence, the effect is diluted.
3	Capital inflows put upward pressure on the currency and export competitiveness falls	A higher rate attracts funds into domestic assets, the currency strengthens, exports become dearer in foreign currency and export volumes come under pressure.
4	It lends emergency funds to solvent banks that are short of liquidity, so that a bank run does not spread	Lender of last resort addresses liquidity, not insolvency; the purpose is to protect confidence in the payment system.
5	A gap of 3 percentage points; capital tends to flow in	5% minus 2% is 3 percentage points; the gap attracts yield-seeking funds, though expected depreciation can reverse the flow.
6	The central bank buys large amounts of longer-term assets to push down long-term yields and expand its balance sheet; it bypasses the zero lower bound but risks asset bubbles and a difficult exit	Long rates such as mortgage rates matter more for investment decisions, so buying long bonds pushes them down directly; but draining that liquidity too fast on exit can jolt markets.
7	Monetary policy is run by the central bank with interest rates, reserve requirements and open market operations; fiscal policy is run by the government with taxes and public spending	The practical test is the actor: reserve ratios signal monetary policy, while tax rates and infrastructure spending signal fiscal policy.
8	About 4.0%	(1 + 0.03) x (1 + 0.01) – 1 = 4.0%; the central bank sets the nominal rate and the real rate is what inflation then delivers.
9	Excess reserve ratio 5.0%, effective multiplier 6.67, below the theoretical 10	100 / 2,000 = 5.0%; the effective multiplier is 1 / (0.10 + 0.05) = 6.67, so idle reserves reduce the real expansion power.
10	It ignores lags and uncertainty: policy works through credit, investment and demand, usually taking several quarters, and the size of the effect is hard to predict	A hike hits short-term rates and the currency first, then investment and jobs, and only later prices; and if inflation is supply-driven, a hike can do little.

04　What to do after marking

After marking, redo only the wrong items and write down which step went wrong (formula, unit, or misread number).
Repeat the same item two days later; move to the next paper only when both attempts are correct.
Parents only need the answer and note columns; there is no need to explain every item.

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