Policy In Action

Question 1

Design of MP

Answer 1

• Nominal money growth targeting
• Inflation targeting
• Interest rate rules (Taylor rule)

Question 2

Deisgn of FP

Answer 2

• Intertemporal budget constraints
• Ricardian equivalence
• Rules and constraints

Question 3

In SR, expansionary MP affects output….

Answer 3

….decrease in interest rate and a depreciation of currency, both lead to an increase in output

Question 4

Under fixed exchange rates, MP is…

Answer 4

…lost. It’s simply used for accommodating FP

Question 5

In MR, MP is…

Answer 5

…. Neutral. Changes in money have no effect on output or employment. Leads to a proportional increase in prices however

Question 6

Problems with Nominal money growth

Answer 6

Design depends on a crucial relationship between money growth and inflation. In reality, it isn’t

Question 7

Central banks primary goal for SR and MR

Answer 7

Inflation targeting, low stable inflation

Question 8

SR MP is movements in the…

Answer 8

…. Nominal interest rate

Question 9

Costs of Inflation

Answer 9

1) Shoe leather costs
2) Tax Distortions
3) Money Illusion
4) Inflation Variability

Question 10

Benefits of Inflation

Answer 10

1) Seignorage
2) Option of Negative IR
3) Money Illusion revisited

Question 11

Inflation Targeting

Answer 11

For the medium run. Provides greater clarity to consumers and firms about what the intentions for the central bank are in the MR. SR targeting is not sensible as may take focus away from output fluctuations

Question 12

Philips Curve Relation

Answer 12

πt = πt-1 - a(Ut-Un)

Question 13

Taylor Rule

Answer 13

it = i* + a(πt - π*) - b(ut - Un)

Interest rate directly affects spending.

Question 14

In SR, expansionary FP leads to…

Answer 14

… higher output, increase in trade deficit. Effect on investment in ambiguous

Question 15

In MR, expansionary FP leads to…

Answer 15

…. change in the composition of output, higher interest rates and lower investment

Question 16

In LR, expansionary FP leads to….

Answer 16

… lower national savings, lower investment, lower capital accumulation and lowers levels of long-run output

Question 17

In an open economy, FP is…

Answer 17

… more effective under a fixed exchange rate compared to a flexible one

Question 18

Government debt during year t (Bt) is the sum of two variables

Answer 18

Past debt and current deficit

Bt = Bt-1 + Current Deficit

Question 19

Budget deficit has two terms

Answer 19

Budget Deficit = rBt-1 + (Gt-Tt)

Question 20

Primary deficit

Answer 20

Gt>Tt

Question 21

Interest payments are measured as…

Answer 21

…real interest payments rather than as actual interest payments

Question 22

Gov budget constraint equation

Answer 22

Bt - Bt-1 = rBt-1 + (Gt - Tt)

Question 23

Debt-to-GDP ratio

Answer 23

helps us understand the size of the debt relative to being able to pay it back

Question 24

The change in debt ratio over time is equal to two sums:

Answer 24

1) Difference between real interest rate and growth rate multiplied by the initial debt ratio
2) ratio of the primary deficit to GDP

Question 25

Normal case of debt/GDP ratio

Answer 25

Growth rate is smaller than the real interest rate and thus (1 + r) - g > 1

Question 26

Three ways to get out of a debt crisis

Answer 26

1) Generate sufficient primary surpluses
2) Resort to monetary financing by the central bank
3) Repudiate the debt, in whole or in part

Question 27

Problems with increasing the primary surplus

Answer 27

Creates political uncertainty and increases the risk premium, therefore interest rates

Question 28

Problems with monetising debt

Answer 28

Monetisation of debt will lead to inflation

Question 29

Explanations as to why member countries are subject to constraints on FP

Answer 29

1) to correct the incentive to pass on the costs of fiscal expansion
2) To prevent financial crisis in one country spreading to all other members

Question 30

Summary of RE

Answer 30

Households realise that higher debt today will have to be paid off tomorrow, which means taxes will increase in the future. Essentially lower taxes today means saving for higher taxes in the future

Question 31

Policy response to the financial crisis

Answer 31

Gov used FP to make up private and public demand.

Also used MP to cut interest rates close to zero.