Central Bank Credibility & Inflation Targeting Flashcards
What monetary policy framework was first adopted by New Zealand in 1990?
Inflation targeting
Inflation targeting has been widely adopted by several countries since its inception.
Which countries followed New Zealand in adopting inflation targeting?
Countries such as Canada, the UK, and Sweden
These countries implemented inflation targeting after New Zealand.
What inflation target did the UK adopt in 1997?
2% Consumer Price Index (CPI) target
The UK granted the Bank of England operational independence at this time.
What is one benefit of a credible inflation target?
Anchoring Expectations
A credible target helps economic agents trust the central bank’s commitment to stable inflation.
How does a credible inflation target enhance policy effectiveness?
Modest changes in interest rates can effectively steer inflation toward the target
This occurs without causing excessive volatility in output and employment.
What effect does greater confidence in monetary stability have on long-term interest rates?
It reduces risk premia and leads to lower long-term interest rates
This can result in increased investment.
What happened in the UK after the Bank of England was granted independence?
Inflation expectations stabilised and inflation remained close to the 2% target for much of the early 2000s
This period marked a significant shift in monetary policy autonomy.
What were the challenges to the UK’s inflation credibility?
Credibility was tested during the 2008 financial crisis and the 2022 inflation surge
These events highlighted vulnerabilities in monetary policy amidst economic turmoil.
What was the Bundesbank’s stance on inflation during the 1970s to 1990s?
The Bundesbank maintained a strict anti-inflation stance
This approach helped Germany achieve lower inflation compared to many European counterparts.
What was the impact of the Bundesbank’s policies on inflation before the Eurozone formation?
Germany maintained lower inflation than many of its European counterparts
The Bundesbank’s policies were crucial for economic stability.
Who was Paul Volcker and what was his role in the US Federal Reserve?
Paul Volcker was the chairman of the US Federal Reserve known for aggressive monetary tightening
His policies aimed to restore credibility after the high inflation of the 1970s.
What were the consequences of Volcker’s monetary tightening in the 1980s?
It led to a severe recession in the early 1980s
Despite the recession, long-term inflation expectations declined.
What was the long-term outcome of Volcker’s policies?
Long-term inflation expectations declined, allowing for sustained economic stability in the following decades
This period marked a shift towards more stable economic conditions.
What are supply-side shocks?
Events that lead to inflationary pressures, such as the 1973 and 1979 oil crises
These shocks can challenge central banks’ ability to control inflation without causing recessions.
What recent event challenged inflation targeting frameworks?
The 2021–2022 energy crisis following the Russia-Ukraine war
This crisis created additional inflationary pressures for central banks.
How do persistent government deficits affect central bank credibility?
They can pressure central banks to finance debt through monetary expansion, risking credibility
An example is Argentina’s recurring inflation crises due to fiscal dominance.
What is fiscal dominance?
A situation where government fiscal policy pressures central banks to maintain low interest rates or finance deficits
This can lead to high inflation and loss of central bank credibility.
What political pressures can affect central banks?
Political interference, such as public criticism from government officials
For example, Donald Trump criticized the Federal Reserve in 2018 for raising interest rates.
True or False: Central banks are immune to political pressures.
False
Central banks can be influenced by political actions and statements, which may undermine their independence.
Fill in the blank: The 1973 and 1979 oil crises are examples of _______.
supply-side shocks
These events led to significant inflationary pressures.
What is a potential consequence of central banks financing government debt?
Risk to their credibility
This can lead to inflationary issues and a loss of public trust.
What is the main critique of inflation targeting?
It is not a panacea.
What may happen if a central bank raises rates aggressively during supply shocks?
It may lead to suboptimal outcomes and exacerbate recessions.
Which economies struggled with persistently low inflation during the 2010s?
Japan and the Eurozone.
What does inflation targeting need to be in deflationary environments?
Adaptable.
What has the 2020s shown about the role of credibility in inflation targeting?
Credibility alone is insufficient if inflationary pressures stem from external shocks.
Fill in the blank: Strict inflation targeting may lead to _______ outcomes during supply shocks.
suboptimal
True or False: Inflation targeting has been effective in all economies without any issues.
False.
