Monetary Policy

Question 1

The US Federal Reserve’s target for the Fed funds rate is currently 1-1.25%, lower than its past two decade average near 3.5%. In the year to June the total US inflation rate was 1.5% and the core measure was 1.8%. The Fed’s inflation target is 2%. The US unemployment was 4.6% in July 2017 – people at the US Fed think the US economies normal unemployment rate (or NAIRU) is about 5.0%. Is US monetary policy currently being judged by Fisher’s rule or Taylor’s rule or neither? Explain why. (5 marks)

Answer 1

Taylor if with unemployment as a proxy for GDP target and growth. otherwise neither

Fisher: 1 + r* = (1 + i)/(1 + p)
Neutral real interest rate (r), nominal interest rate (i) and inflation rate (p)
Taylor: i = p + r + 0.5 x ((y – y) + (p – p))
actual GDP growth (y), potential GDP growth (y) and inflation target (p)

Question 2

What are unconventional monetary policies - UMPs? (3 marks). Give two examples of UMP that the US Federal Reserve has used in recent years (2 marks)

Answer 2

Policies that are called on in extreme times when conventional monetary policy no longer works

E.g’s Quantitative easing , signaling, forward guidance, guaranteeing bank accounts up to a certain amount

Question 3

Some central banks in Europe as well as Japan have taken interest rates to negative levels in recent years. What are there constraints on how negative interest rates can go? (3 marks).

Answer 3

Public will hoard cash so lowering further would be of no use therefor UMP becomes necessary.

Question 4

What is “Helicopter money”? (3 marks).

Answer 4

Dropping printed cash into public hands

Question 5

What drives bond rates?

Answer 5

Policy interest rate (which affects inflation expectations) +some growth, VIX and liquidity only in extreme events (QE)