Monetary Institutions and Strategies Flashcards
What is the definition of “Adaptive expectations”?
- Theory that people’s expectations of a variable are based on past levels of the variable; also, backward-looking expectations
Definition of Rational expectations:
- Theory that people’s expectations of future variables are the best possible forecasts based on all available information
the Phillips curve:
Formula
The behavior of inflation depends on expectations
- “p” is inflation,
- “pe“ is expected inflation,
- Y~ is the output gap (the percentage deviation of output from potential),
- “x” is a coefficient showing how strongly output affects inflation
Time-consistency problem
- A situation in which someone has incentives to make a promise but later to renege on it; because of these incentives, others don’t believe the promise
Lack of consistency
Rational Expectations and Costless Disinflation (graph)
Definition of “Conservative policymaker”?
- It is central bank official who believes it is more important to keep inflation low than to stimulate output
governments appoint the policymakers who run central banks.
if policymakers are conservative (or a clear economic believes) , the time-consistency problem disappears. The central bank can promise inflation of “p” ideal and people will believe it.
With what option you solve the time consistency problem of the central bank?
- Conservative Policymakers
- Reputation
- A Policy Rule
How reputation of the head of the central bank can help to solve the time-consistency problem ?
- they would like people to believe that they are conservative (even if they are not). This concern can solve the time-consistency problem.
- When a new chairman is appointed , he/she can decide what reputation want according to it first actions.
- In this theory, it is desirable for policymakers to care a lot about their reputations. This happens if policymakers have long time horizons
how to solve time-consistency with a policy rule?
- The government imposes a rule requiring the central bank to produce low inflation or not
what argument use against the independence of the central bank ?
- Their central argument is a political one: in a democracy, elected officials should control economic policy.
- They fear that the priorities of central banks are those of financial interests, not ordinary citizens
What are the arguments for central bank independence?
- A long-standing argument is that independence protects the Fed from political pressures for unwise policies
- Reduce the time-consistency problem (Conservative Central Bankers and Long Horizons)
Definition of Discretionary policy:
- A monetary policy that is adjusted at each point in time based on the judgment of the central bank
Definition of Monetary-policy rule:
- A simple rule or formula that tells the central bank how to run policy
Who are the Monetarists ?
- They are school of economists who believe that monetary policy has strong effects on the economy and that policy should be set by a rule
what are the problems with discretionary policy according to Monetarists?
- Well-Intentioned Mistakes
- Political Influence (some presidents still had influence)
* All this could be solve with a set of rules
what are the mains types of inflation targeting ?
- Strict targeting
Hitting the inflation target is the central bank’s only goal. If shocks push inflation away from the target, policy pushes it back as quickly as possible.
- Flexible targeting
The central bank is not concerned only with inflation; it also pays attention to the goal of output stability
In practice, it appears that central banks choose flexible inflation targeting.
what are the arguments in favor Inflation targeting ?
- First, in many circumstances inflation targeting naturally stabilizes output as well as inflation.This fact follows from the Phillips curve
- inflation targeting is flexible
what is Transparency for the central bank ?
- providing clear, detailed information about policymaking to the public
how the central bank provided of information ? (tranparency)
- Many central banks issue publications that give the rationale for recent decisions.
- publish the economic forecasts produced by their staffs
- publish minutes of the meetings at which interest rates are set
- officials hold press conferences to explain their actions and take questions
Why Practice Transparency? , according to the central banks
- political
- effect on inflation expectations
- helps policymakers control long-term interest rates
