Macroeconomic Policy

Question 1

What are the policy options available to a central bank in response to demand shocks and inflation shocks?

Answer 1

• Accommodating policy: a policy that allows the effects of a shock to occur, so RBA decreases real interest rates to shift demand to new inflation level
• maintaining low inflation after adverse shock: interest rates remain as high as they were, so economy remains in a recession for awhile until the economy is self-corrected where the AS curve shifts back to pi(e)= Y*

Question 2

What are anchored inflationary expectations?

Answer 2

When people do no expect inflation to remain high after inflation shock as they don’t think an accommodating policy will take place. Largely based on whether bank has a history of using these policies.

Question 3

What are the roles played by anchored inflationary expectations and central bank credibility in keeping inflation low?

Answer 3

Macroeconomic performance may be improved with anchored inflationary expectations.
Anchored expectations depend on the credibility of the central bank.
The credibility is based on:
- independence (from its government)
- announcement of inflation target
-is the bank an ‘inflation hawk’?

Question 4

How does fiscal policy affect both aggregate demand and aggregate supply?

Answer 4

Demand is obviously affected by via PAE, as increased PAE by the government means that overall people are wealthier.
AS is affected by supply-side polices that affect aggregate output. For example, better infrastructure leads to be better productivity overall.
Reduction in marginal tax rates means people buy more shit, which contributes to greater potential output (though the exact significance is controversial).

Fiscal policy makers should consider effects of spending (exogenous changes in PAE) and tax decisions on potential output, as well as AD.