Chapter 23: Monetary Policy Theory Flashcards
inflation target
used to maintain inflation and is slight above zero
inflation gap
the difference between inflation and inflation target
aggregate demand shock and MP
Fed is able to target price stability and economic stability
permanent supply shocks and MP
Fed is able to target price stability and economic stability
temporary supply shocks and MP
Fed is only able to target price stability or economic stability
aggregate demand shock no policy
SR: change in Y and inflation
LR: shift in AS which only affects inflation
aggregate demand shock with policy
SR: change in Y and inflation
LR: shift in AD which returns it to normal
permanent supply shock no policy
SR: change in Y and inflation
LR: AS shifts to LRAS which changes Y and inflation even more
permanent supply shock with policy
SR: change in Y and inflation
LR: inflation returns to target and Y is at new potential
temporary supply shock no policy
SR: change in Y and inflation
LR: AD shifts so Y and inflation returns to normal
temporary supply shock with policy
SR: change in Y and inflation
LR: AD shifts so either inflation returns or output returns, but not both
divine coincidence
when no conflict exists between the dual objectives of stabilizing inflation and economic activity
nonactivists
- believe wages and prices are flexible
- self-correcting mechanisms work fast
- government action is unnecessary
activists/Keynesians
- self-correcting mechanism are slow
- government should purse active policies
data lag
the time it takes for policymakers to obtain the data
recognition lag
the time it takes for policymakers to feel confident about the signals the data are sending about future course of the economy
legislative lag
the time it takes to get legislation passed to implement a particular policy (fiscal)
implemntation lag
the time it takes for policymakers to change policy instruments once they have decided on a new policy
- specifically fiscal policies
effectiveness lag
the time it takes for the policy to have a real impact on the economy
Inflation and policymakers
- monetary authorities can target any inflation rate in the LR with autonomous MP adjustments
- potential output is independent of monetary policy
types of inflation
- cost push inflation
- demand pull inflation
cost push inflation
results from a temporary negative supply shock or push by workers for wage increases that are beyond justified by productivity gains
demand pull inflation
results when policymakers pursue policies that increase aggregate demand
cost push vs demand pull inflation
cost push - unemployment is above natural level
demand pull - unemployment is below natural level
self-correcting mechanism at zero lower bound
- self-mechanism is no longer operational
- economy goes into deflationary spiral by continually falling inflation and output
- Y < Yp => pi falls => r rises => Y falls …
Nonconventional MP
liquidity provision, asset purchases, and management of expectations
zero lower bound and liquidity provision
increases leading facilities to shift AD to the right
zero lower bound and asset purchases
lowers credit spreads to shift AD to the right, but if wrong assets are purchased there can be a minimal effect on the economy
zero lower bound and management of expectations
forward guidance to shift AS to the left, but if not credible, this will not work
