Econ Test 3 - Conducy of Monetary Policy: Strategy and Tactics Flashcards
What do central bankers define as low and stable inflation?
price stability
What do central bankers define price stability as?
low and stable inflation
Why is price stability desirable?
a rising price level creates uncertainty in the economy which might hamper economic growth
What is inflation?
a rising price level
What does inflation do to the economy?
creates uncertainty in the economy which might hamper economic growth
When is the information conveyed by the prices of goods and services harder to interpret?
When the overall level of prices is changing
How doe the public feel towards inflation?
hostile
A nominal variable such as the inflation rate or the money supply, which ties down the price level to achieve price stability.
nominal anchor
What is a central element in successful monetary policy?
The use of a nominal anchor
What does adhering to a nominal anchor do to price stability?
promotes it by promoting low inflation expectations
What is monetary policy conducted on discretionary, day by day basis leading to poor long-run outcomes?
time-inconsistency problem
An example of the time-inconsistency problem
A New Years resolution to lose weight but the short-run is easier than the long-run gains
Why is the best policy to not pursue expansionary policy?
because people see a central bank pursuing expansionary policy workers and firms will raise expectations about inflation
What happens when workers and firms raise their expectations about inflation?
drives wages and prices up
Five goals continually mentioned by central bank officals?
high employment econ growth stability of markets interest rate stability foregin exhange market stability
What does unemployment result in?
Loss of output or lower GDP
What are searches by workers and firms to find suitable matchups?
frictional unemployment
A mismatch between job requirements and the skills or availability of local workers
structural unemployment
The goal for high employment is?
a level above zero consistent with full employment a which the dmeand for labor equals the supply of labor
When the demand for labor equals the supply of labor
natural rate of unemployment
The rate of output tied to the natural rate of unemployment
potential output or natural rate of output
What do upward movements in interest rates generate?
Hostility toward central banks and a demand that their power be curtailed
What generates hostility toward central banks and leads to demands that banks powers be curtailed?
upward movements in interest rates
How does an increase in interest rates affect affect long-term bonds and mortages?
produce large capital losses
Why is interest-rate stability desirable?
because fluctuations in interest rates can create uncertainty in the economy and make it harder to plan for the future
A rise in the value of the dollar makes American industries less/more competitive with those abroad?
less
A decline in the value of the dollar does what to inflation in the United States?
stimulates
Preventing large changes in the value of the dollar makes it easier for firms and individuals to do what?
plan ahead
Does higher inflation affect employment in the long run?
NO
In the short run price stability conflicts with what?
the goals of output stabliity and interest rate stability
How would a central bank prevent an overheating of the economy?
raising interest rates
How does a rise in interest rates affect output initially?
cause output to fall
What is the primary long-run goal for central banks?
price stability
Mandates that put the goal of price stability first and then say that as long as it is achieved other goals can be pursued
hierarchical mandates
Long-term interest rates will be high if what is high?
inflation
What is to achieve two coequal objectives: price stability and maximum employment?
dual mandate
What are the goals of the dual mandate?
price stability and maximum employment
What is the difference between dual mandate and hiearchical mandate?
Hiearchical focuses on one objective while dual focuses on two coequal objectives
What kind of inflation rates promote economic growth?
Low and stable
Why do central bankers often favor hierarchical mandates to dual mandates?
concerns that a dual mandate might lead to overly expansionary policy
When does a dual mandate become a problem?
When price stability is a short-term goal
When expansionary policies are pursued as short-run goals
Are either type of mandate acceptable?
yes
What includes public announcement of inflation objectives, commitiment to price stability, information-inclusive approach using many variables, transparency of the monetary poly strategy though public comm, and increased central bank accountability?
inflation targeting
What was the first count to adopt inflation targeting?
New Zealand
A key advantage of inflation targeting is that it can help focus the political debate on what?
What a central bank can do in the long run, rather than what it can not do
Can a central bank permanently increase economic growth and the number of jobs through expansionary monetary policy?
NO
Inflation targeting has the potential to reduce the likelihood that the central bank will fall into what?
the time-inconsistency trap
Does the public understand inflation targeting?
YES
What can the New Zealand regime do if the inflation target is breached, even for one quarter?
Dismiss the Reserve Bank’s governor
Inflation targeting has made who highly accountable?
The central bank
How would you classify the success of inflation targeting?
Quite good.
What are delayed signaling, too much rigidity, potential for increased output fluctuations, and low economic growth?
Disadvantages of Inflation Targeting
What is the issue of the inflation target being unable to send immediate signals to the public and the markets about the stance of the monetary policy?
Delayed signaling
What is the complaint about the rigidity of inflation targeting?
Limits the ability of monetary policymakers to respond to unforseen circumstances
Why must monetary policy be forward-looking and preemptive?
to prevent inflation from getting started because if they start when inflation is reported then it’s already too late
The Fed’s forward looking behavior and “just do it” approach helps to discourage what?
overly expansionary monetary policy
Discouraging an overly expansionary monetary policy does what to the time-inconsistency problem?
ameliorates it
Has the Fed’s “just do it” approach worked in the past?
YES
What is the most serious problem with the Fed’s “just do it” approach?
Its strong dependence on the preferences, skills, and trust of the individuals in charge of the central bank.
Is the Feds “Just do it” approach transparent?
NO
What kind of impact do developments in the financial sector have on economic activity?
far greater than earlier realized
Why can zero-lower-bound on interest rates be a serious problem?
It forces the Federal Reserve to use nonconventional monetary policy tools that are harder to use effectively.
What is the cost of cleaning up after a financial crisis?
Very high
Does price and output stability ensure financial stability?
NO
What is the typical inflation target?
2%
What are pronounced increases in asset prices that depart from fundamental values which eventually burst resoundingly?
asset-price bubbles
Are asset-price bubbles easy to identify?
No they are nearly impossible
Are increases in interest rate an effective tool in trying to restrain bubbles?
No, in fact it has often caused a bubble to burst more severly
Why are monetary policies ineffective against asset-price bubbles?
These policies target the general view instead of the specific asset experiencing a bubble
How does a rise interest rates affect employment?
raises unemployment
How can policymakers keep the harmful affects of a burst asset-price bubble to a minimum?
By responding in a timely fashion
Characterized by a surge in prices that raises expectations until the bubble bursts and prices rapidly revert to an objectively-based level
Asset-price bubble
What can a credit-driven bubble cause that is so dangerous?
a feedback loop
When a credit boom drives up asset prices which in turn fuels the credit boom which drives asset prices even higher and so on
the feedback loop
What happens to the feedback loop when the credit-driven bubble bursts?
the loop reverses and loans go sour and demand for assets declines
What is the key principle in designing effective policies to lean against credit booms?
curb excessive risk taking
Regulatory policy to affect what is happening in credit markets in the aggregate is referred to as?
macroprudential regulation
A variable that responds to the central bank”s tools and indicates the stance of monetary policy?
policy instrument
What are the two basic types of policy instruments that the Fed has at its disposal?
reserve aggragates
interest rates
A rightward or leftward shift in the demand curve for reserves leads to what?
fluctuations in the federal funds rate
A right or left shift in the demand curve for reserves leads to the central bank doing what?
shift the supply curve of reserves so that the federal rate does not change
Are interest-rate and reserve aggregate compatible?
NO
What two policies must the central bank choose between?
interest rate
reserve aggregate
What is the interest rate that is easiest to measure and observe?
the nominal interest rate
What are more observable: interest rates or reserve aggregates?
short term interest rates
What criteria is used when selecting a policy instrument?
observability
controllability
predictable effects
If a variable is to function as a useful policy instrument what must a central bank be able to do?
exercise effective control over it
If the central bank cannot control the policy instrument then what happens?
the bank won’t be able to get the policy back on track
What is the most important characteristic of a policy instrument?
It must have a predictable effect on a goal
What policy instrument do central banks throughout the world generally use these days?
short-term interest rates
Who coined the Taylor Rule?
John Taylor of Stanford fame
This rule indicates that the federal funds rate should be set equal to the inflation rate plus and equlibrium real feds fun rate plus a weighted average of two gaps.
Taylor Rule
According to the Taylor rule
Federal funds rate target =
inflation rate + equilibrium real fed funds rate + 1/2(inflation gap) + 1/2(output gap)
The principle that the monetary authorities should raise nominal interest rates by more than the increase in the inflation rate has been named?
The Taylor Principle
What happens if real interest rates fall when inflation rises?
Serious instability occurs
If the Taylor principle is not followed what occurs?
nominal rates rise by less than the rise in inflation
This theory indicates that changes in inflation are influenced by the state of the economy relative to its productive capacity as well as by other factors
Phillips Curve Theory
What does NAIRU stand for?
non accelerating inflation rate of unemployment
If the unemployment rate is above NAIRU with output below potential then what will happen to inflation?
Inflation will come down
If the unemployment rate is below NAIRU with output above potential, what will happen to inflation?
rise
Taylor’s rule suggests that the Fed increase interest rates when?
times of high inflation or when employment is too high
Taylor’s rule suggests the Fed decreases interest rates when?
Times of low inflation or when employment is below full employment levels
What is the key element in a successful monetary policy?
having a strong nominal anchor
How does a nominal anchor promote price stability?
tying down inflation expectations
limiting time-inconsistency problems
What are developments in the financial sector have a greater impact on econ than earlier realized, zero-lower-bound interest can be a serious problem, the cost of cleaing up after a financial crisis is high, and price and output stability do not ensure financial stability?
Four lessons that can be learned from the global financial crisis
The lessons from the financial crisis provide an argument for what?
More flexible inflation targeting
What did the argument for not responding to bubbles in general rest on?
Expectations that market participants are smarter than Fed officials and would know when asset prices are out of line
