Stabilization Policy Flashcards
What were the findings of Friedman and Schwartz’s critique of stabilisation?
That stabilisation policy can be destabilising because it can only affect unemployment and output with a long and variable lag.
Policy recommendation: to just focus on P, inflation and M policy rather than output and unemployment.
Define inside lag
Includes the recognition, decision and implementation. The lag between the identification of a need for a policy decision and a policy decision is executed.
Problems with estimating ygap?
In the case of the Taylor Rule, the only way to estimate present ygap via trendline is to wait 2.5 more years in order to draw a viable line to estimate current ygap.
Problems related to the decision lag?
Need to convince all 12 members of the FOMC to go with your stabilisation policy.
Problems related to the implementation lag
The time it takes to implement a policy once it has been decide. For instance, the Fed will only move the nominal interest 25 basis points at a time (0.25%). Therefore, in order to move the target nominal interest rate from 0 to 4, for instance, it will take 16 FOMC meetings, or 2 years since the FOMC only meets 8 times a year.
Define outside lag
Time it takes for the policy instrument to affect the economy
Outline the destabilising effects caused by lags of a change in monetary policy
Easy M could cause output to exceed desired levels, and tight M to offset the excess output may cause output to plunge further below desired levels of output.
Outline the views on Fed stabilisation policy
Martin Chesney:
Fed should take away the punch bowl just when the party is really warming up.
Friedman and Schwartz:
Fed should not be throwing parties in the first place - should instead maintain stable price policy even when inflation is under control.
Krugman:
Condemns worries about inflation even in the absence of inflation as sado-monetarism.
Why has inflation not taken off despite the expansion in the monetary base?
Current FFR near 0.
Inflation barely 2% since 2008.
How has the Fed neutralised its own ability to affect the money supply via a base expansion/ contraction?
By paying interest on excess reserves, which has permanently led banks to keep higher excess reserves due to the zero/negative opportunity cost. (calculated through i - ix)L.
