9. The conduct of monetary policy

Question 1

Why might a positive inflation be better than zero inflation?

Answer 1

Cost of disinflation: central bank needs to tighten money supply which leads to reduced output and employment

Avoiding liquidity traps: Reduces risk of a liquidity trap

Question 2

What are policy goals of a central bank?

Answer 2

Output stability and inflation stability

Question 3

Why doesn’t disinflation require an output loss under rational expectations?

Answer 3

According to the Phillips curve, inflation equals expected inflation and the output gap.

If the central bank reduces expected inflation, inflation can be reduced without reducing output.

Question 4

What is a monetary hawk?

Answer 4

Someone who advocates for keeping inflation low as the top priority of monetary policy.

–> more in favor of tight monetary policy

Question 5

What is a monetary dove?

Answer 5

Someone who emphasizes other issues than inflation, such as, low unemployment

–> more in favor of expansionary monetary policy and low interest rates

Question 6

What is discretionary policy?

Answer 6

Central bank acts at each point in time based on its judgement of what is good for the economy.

–> How the Fed operates

Question 7

What is a monetary-policy rule?

Answer 7

Is a simple rule or formula which tells what the central bank must do.

Question 8

Why did monetarists believe that discretionary policy did more harm than good?

Answer 8

1. Policymakers can make well-intended mistakes
2. Policymakers can succumb to political pressure
3. Time-consistency problem

Question 9

What are benefits of explicitly targeting inflation?

Answer 9

Reduces danger of discretionary policy

Anchors inflation expectations