W8P4 - Notebooklm Flashcards
What was the primary target of monetary policy for many central banks before the end of the 1980s or early 1990s?
The money supply.
What made targeting the money supply more difficult starting from the end of the 1980s or early 1990s?
The money multiplier (the ratio between M1 and M0) became less stable.
What is the primary tool most central banks use for monetary policy nowadays?
Setting the interest rate.
What is “inflation targeting”?
Setting an explicit or implicit inflation target (e.g., 2%) and then setting interest rates accordingly.
How are interest rates typically adjusted in line with inflation targets?
Via repurchase rates.
Provide an example of a central bank gaining independence from the government and the year it occurred
The Bank of England in 1997.
Who sets the inflation target for the Bank of England after it became independent?
The government.
What is a “Taylor Rule”?
Essentially a rule for setting nominal interest rates in the economy, often based on inflation and output.
According to the basic Taylor Rule (Equation 20), how does inflation expectations being above the target influence the nominal interest rate?
It leads to an increase in the nominal interest rate.
According to the basic Taylor Rule (Equation 20), how does a positive output gap influence the nominal interest rate?
It leads to an increase in the nominal interest rate.
What is the relationship between the nominal interest rate (i), the real interest rate (r), and inflation (pi)?
The real interest rate (r) is the nominal rate (i) minus inflation (pi).
Why must the parameter (alpha) on inflation expectations in the Taylor Rule typically be larger than one?
Because the central bank aims to increase the real interest rate when inflation is expected to increase. To do this, the nominal rate must increase by more than the increase in inflation to reduce investment and cool down the economy.
What body in the UK decides on the interest rate, and how often does it typically meet?
The Monetary Policy Committee (MPC), which meets approximately every six weeks.
What is the “three equations model” comprised of?
An IS schedule, a Phillips curve, and a Taylor rule.
In the three equations model, how does an increase in nominal interest rates (relative to inflation expectations) affect the output gap?
It reduces investment and therefore reduces output, leading to a more negative or less positive output gap.
What was a significant limitation faced by monetary policy during the financial crisis starting in 2007-2008?
The zero lower bound for interest rates.
What unconventional monetary policy tool did central banks use in response to the zero lower bound? What was its primary goal?
Quantitative easing (QE), with the aim of bringing down long-term interest rates.
Name two types of policy that have received increased focus since the financial crisis.
Macroprudential regulations and forward guidance.
Why is credibility important for the effectiveness of forward guidance?
If the central bank is credible, its announcements about future inflation can influence inflation expectations without necessarily requiring immediate interest rate changes.
What has been observed regarding monetary policy across different central banks in the years since the financial crisis?
It has become more heterogeneous.
What is the ongoing process of “unwinding” quantitative easing generally involve?
Central banks getting rid of the bonds they acquired during QE.
