Monetary Economics

Question 1

Functions of Money

Answer 1

1. Storage of Value
2. Unit of account
3. Medium of exhange

Question 2

Characteristics of “good” money

Answer 2

Authentificatin/uniform quality
Diversibility
durability
ease of transportation/Exchange
low cost of production
steady supply

Question 3

Nominal GDP meassurement

Answer 3

Expendiature Approach
Value added approach
income approach

Question 4

Real GDP

Answer 4

Nominal GDP /1+ \inflation

Question 5

Emperical Evidence about Money

Answer 5

Long-run: Money is neutral in the long run and has no effect on real variables

short run: Non-neutrality. Due to price regidities monetary policy can have real effects in the short run.

Question 6

Money in Utility Model

Answer 6

holding money gives individuals utility in itself. This can be related to the lequidity theory.

money demand is decreasing in the nominal interest rate.

money demand is increasing in consumption

money demand is decreasing in the inverse lequidity preference

Question 7

Euler Equation

Answer 7

marginal rate of intertemporal consumption = marginal rate of technical substitution

Question 8

Euler Equation

Answer 8

marginal rate of intertemporal consumption = marginal rate of technical substitution

Question 9

Fisher Equation

Answer 9

1+rt = 1+it /(1+pit+1)

Question 10

The Classical Model

Answer 10

real variables only depend on real tings - money is neutral

prices are perfectly flexible
doubleing the money supply will just double the price level i.e. the wages and has no real demand effect

In conjunction with the Quantety theory of money we come to the conclusion, that a low level of inflation is the best solution, since high inflation imposes costs.

Question 11

Neutrality of Money

Answer 11

Neutrality: The economy is independent of the initial level of money
Super Neutralitiy: The economy is independent of the growth rate of money.

Question 12

Equation of Exchange

Answer 12

Mt vt = Pt yt

with the logs and then the difference we obtain the growth representation and the Quantety theory of money

Question 13

Quantety theory of Money

Answer 13

increasing the money growth increases inflation 1 to 1

increasing the output growth increases inflation 1 to 1

increasing the growth of the velocity increases inflation 1 to 1.

Question 14

Costs of inflation

Answer 14

higher inflation gives higher nominal interests thus a lower preference for holding money. But holding money gives utility. Thus holding less money decreases the utiity.

• maintain a low inflation.

Question 15

Independence of a CB

Answer 15

Government only sets a target but leaves the methods to achieve it in the hands of the CB

Question 16

Active Policy of a CB

Answer 16

CB reacts to changes in the Business Cycle

Question 17

Passive CB

Answer 17

Does not react to the Business Cycle i.e. applies a fixed money growth policy.

Question 18

Transmission mechansisms

Answer 18

Expectation channel
Money and Credit cahnnel
Assetprice channel
Bank-rate channel
Exchange rate channel

Question 19

Instruments of a CB

Answer 19

policy rates
minimum reserves
open-market operations/transactions
QE

Question 20

Inflation Target vs. Money Target

Answer 20

Since inflation transitions to demand thus to the real economy, a fixed inflation target for a given period with a continious adjustment of the money supply reduces volatility in the real economy.

Question 21

Taylor Rule

Answer 21

i = alpha + alphapi(pit-pi) + alphay(yt-y)

Question 22

Taylor Principle

Answer 22

CB should follow a agressive Taylor rule alphapi > 1 to have a uniquely defined inflation.

Question 23

FED in the 1970 pre Volker and after

Answer 23

The estimation of the Taylor rule is not possible due to endogeneity

Question 24

Cholesky Decomposition

Answer 24

pro:
simple implementation
easy to understand: ranking of exogeneity
checking for robustness by changing the ordering (should not be done!)

Contra:

• too many choices
• Timing causality becomes problematic in highly aggregated data. What holds on a day to day basis does not hold in Quarter by Quarter timing.
• Risk of picking a ordering that gives significant results (confirmation bias)

Question 25

Romer and Romer (2004)

Answer 25

Used announcements of the FED to determine the intended interest rate - regressing all explanatory variables of macro model on the announced interest rate - the given residuals are the monetary shocks, the unanticipated monetary changes.

Using these generated shocks in the model should overcome the endogeneity and intercorrelation problem.

Question 26

Narrative Approach (Romer and Romer)

Answer 26

pro:

• once the shocks are created it is easy to use
• more plausible than the Choleskey decomposition

Contra:

• More work to estimate
• Black box (“how are the shocks are estimated if not doin the estimation by yoursef”)
• Results are highly sensitve i.e. inclusion of Volcker period.

Question 27

Reasons for price stickiness

Answer 27

Cotraction friction

Menu Costs

Question 28

New Keynesian Model

Answer 28

Based on Calvo pricing we obtain price stickiness by introducing a market for intermediate goods where an continioum of firms are only allowed to adjust their prices with a certain probability at any given period.

This leads them to anitcipate the inflation and take that into account to build their current price. The less likely they are able to change the price the higher, if there is positive inflation

Question 29

NKPC - Explain the parts of the equation.

Answer 29

pi = ß E pit+1 kappa xt + et

et is the cost-push shock

Question 30

cost push shocks

Answer 30

price increase on foreign not locally substitutable goods. i.e. oil price shock, exchange rate shock caused by another country. Cost shocks in other raw materials that need to be imported.

Question 31

IS Equation - What are the parts of the equation and why are they included?

Answer 31

x = Ex - sigma (i_t - E pit+1 - re)

alternative version with vt as the consumer sentiments

Question 32

Money Demand

Answer 32

m = gamma y - gamma i + ut

Question 33

Optimal monetary policy

Answer 33

Based around the loss function derived from the household utility gives the utility maximizing or to be precise the utility loss minimizing CB policy for a given shock.

Question 34

Optimal monetary policy

Answer 34

Based around the loss function derived from the household utility gives the utility maximizing or to be precise the utility loss minimizing CB policy for a given shock.

Question 35

Loss function

Answer 35

BAsed on the representive Households utility one can approximate a loss function, it is square in the deviation from the target inflation and the output gap.

Thus setting both deviations to zero would be optimal.

Question 36

Divine Coincedince

Answer 36

In the absence of cost-push shocks the CB should follow with the nominal interest rate the natural interest rate. (wicksel rate)

Would still have recessions even if the output gap is zero. The natural level of output can decline.

Question 37

Comittment

Answer 37

CB decides on a policy path and sticks/Commits to it. This commitment is assumed to be credible.

Question 38

Discression

Answer 38

CB decides every period about their policy

Question 39

Comittment vs. Discression

Answer 39

Pro Comittment:

• manages expectations (i.e. forward guidence)
• reduces uncertainty
• can constraint incompetent policy makers

Contra:

• time inconsistent
• world is too complex for a comitment “rule”
• reduces the flexibility in the reaction to a crisis “can all crisis be foreseen ?

Question 40

Comittment vs. Discression

Answer 40

Pro Comittment:

• manages expectations (i.e. forward guidence)
• reduces uncertainty
• can constraint incompetent policy makers

Contra:

• time inconsistent
• world is too complex for a comitment “rule”
• reduces the flexibility in the reaction to a crisis “can all crisis be foreseen ?

Question 41

Strict inflation targetting vs. Flexible targetting

Answer 41

keeping inflation down at all costs is not optimal, sometimes a focus on unemployment or economic growth might be reasonable.

As we saw the utility depends on the output gap and the inflation.

Question 42

Zero Lower Bound

Answer 42

Liquidity trap. The nominal interest rate has reached the lowest possible level compared to the outside option of holding cash.
Saturated Money Demand.

Question 43

Price Level targetting

Answer 43

Functions as a typ of short term comittment. CB has to initiate an above target inflation to get price level back on target. Like in the case with comittment.

Question 44

Speed limit rule

Answer 44

changes in the nominal interest rate are limited. The problem is there are not only cost-push shocks in the world.

Question 45

Quantitative Easing

Answer 45

Vanilla QE:
Does not work:
- exchanging bonds for money does not effect demand if they are just substitutes.
- Households are not made richer by Vanilla QE
- No inflation, since the velocity drops in the level the monetary base increases.

Question 46

QE Alternatives

Answer 46

Operation Twist - lowering long run interests by exchanging short term bonds or money for long term ones.

Dircect purchase of privat assets

Question 47

Helicopter money

Answer 47

Is not a monetary policy, since it can be used to pay off tax debts. Thus is equivalent to a tax cut, hence a form of fiscal policy.