6- Monetary & Fiscal policy Flashcards
How did Central Banks respond to Covid?
They implemented unprecedented expansionary monetary policy lowering policy rates to ZLB and committing to QE like never before
Why did Central Banks respond to Covid how they did?
High uncertainty and scarring from the weak recovery post GFC meant they wanted to err on the side of doing more
Why was Central Banks’ response to Covid imperfect?
Slowdown was different to GFC as nothing was inherently wrong with economy so there were no structural changes to risk appetite and demand picked up again quickly
What were the 2 main targets of fiscal policy during Covid?
-Protecting jobs and income (e.g. furlough pay)
-Increase economic activity (e.g. stimulus cheques)
How did Monetary aggregates change during Covid and how did it differ from GFC?
Central bank liquidity injections translated to large increases in broad money supply mainly because there was no structural risk aversion to inhibit transmission
Outline how global supply chain disruptions led to inflation
Unscheduled factory closures and trade barriers made it more difficult to source intermediate goods so production was more costly
How did consumer behaviour exacerbate the supply disruptions problem?
Covid restrictions meant money mainly went to goods and disruptions meant supply couldn’t keep up such that more money chased fewer goods
What were 2 main external inflationary shocks post-pandemic?
-Ukraine war: Sharp rise in commodity prices affecting energy prices and food costs
-Brexit: More trade barriers with the EU and administrative frictions
What did central banks incorrectly believe about inflation expectations?
Assumed because expectations were anchored for so long that the short term shocks wouldn’t de anchor them
Why were central banks wrong to assume anchored inflation expectations?
If inflation is persistently above target, expectations begin to de anchor
How did Phillips curve interpretations fail to predict inflation?
The curve was flat pre-pandemic with low unemployment not causing inflation, however labour market tightness showed the curve was non-linear beyond NAIRU
What are the 2 forms of debt issued by the government?
-Money (Issued by central bank)
-Bonds (Issued by treasury)
What are the 3 main ways governments finance their expenditure?
-Tax revenue
-Seigniorage from printing new money
-Issuing Bonds
What are the 2 main government outflows?
-Spending on goods and services
-Paying back interest on bonds
What happens when the growth rate of the economy exceeds the real interest rate (r < n)?
Number of goods the economy gains is higher than the number of goods the government has to repay
What happens when the real interest rate exceeds the growth rate of the economy (r > n)?
Issuing bonds means you have to pay back more than the economy is yielding so has to be compensated by an increase in tax or seigniorage revenue
Why is central bank independence important?
Independent policy promotes credibility thus solidifying expectation anchor
What have been the 2 main central bank responses to recent high inflation?
-Raising policy rates
-Quantitative tightening
Why may government pressure affect central bank policy?
Governments are incentivised to reduce their borrowing costs, if the public believes rates aren’t high enough because of this, it will damage credibility
What is monetary financing?
Selling bonds to the central bank to cover spending
What must the central bank make clear when buying government bonds?
To emphasise independence: They are buying as part of quantitative easing to meet inflation objectives and are not monetary financing
