Week 2 Flashcards
The natural interest rate is the interest rate where…
…the economy is stablized in the absence of output gap and when inflation equals its target.
The deflation trap is:
-“a thing we teach in school to keep you busy, but will never really happen”
-something that happens when the economy is going at full speed
-a potential reason for using Quantitative easing
-none of the above
a potential reason for using Quantitative easing
In the 3 equation model there is NOT an equation for:
- the goods market
- the stock prices
- the monetary policy
- Inflation
the stock prices
Why would a central bank want to ever raise the inflation target
- so it is further away from the Zero lower bound
- so it can work less
- so it looks like it is always right
so it is further away from the Zero lower bound
Potential output is:
… Output at its full employment level
Which of the following is NOT an explanation for deficit bias in fiscal policy making?
1.There is intergenerational conflict
2.Growth forecasts are uncertain
3.The central bank is not sufficiently independent
4.The output target is overly ambitious
The central bank is not sufficiently independent
Why do governments hand over inflation targeting to the central bank?
Govs hand over inflation targeting to CBs mainly for 2 reasons:
- Governments have political pressure to manipulate interest rates for electoral gain.
- Monetary policy is preferred over fiscal policy to stabilise the economy since it is quicker and more fair.
How would CB respond to rising inflation?
In response to an upward inflation, central banks would raise interest rates.
The cut back in investment, due to higher financing cost, would lead to a lower aggregate demand.
Output would fall, unemployment would go up and inflation would go down.
In which situations in you cannot rely on the central bank to stabilize shocks by changing the interest rates?
There are two situations in which you cannot rely on the central bank to stabilize shocks by changing the interest rates:
- When there is such a large negative demand shock that even when the central banks changes the nominal interest rate to zero, this is not low enough to stimulate a revival of aggregate demand through investment. (Zero Lower Bound)
- When the economy has a fixed exchange rate in for example a common currency area such as the Eurozone. There is an overall ECB, so countries cannot stabilize shocks that are specific to their countries as they do not have their own monetary policy maker.
Claim: Rising inflation is often followed by painful periods of disinflation where output is below equilibrium, accompanied by high unemployment.
TRUE
What is the Shoe-leather-cost?
Shoe-leather-cost is the cost of time and effort people spend managing their financial assets to minimise the effect of inflation on the eroding purchasing power.
Why target low and stable inflation?
The CB targets low and stable inflation because:
- Periods of high inflation are accompanied with inflation volatility which distorts resource allocation.
- Firms incur costs due to the need for frequent price changes if there exists volatile inflation, called menu costs.
- When inflation is high, people want to hold less money as inflation erodes value over time (shoe-leather-costs).
What is Fiscal Policy?
A government policy trying to raise revenue through taxation and distributing that revenue as public expenditure.
The MR curve shows …
…the central bank’s preferred output-inflation combination for any Phillips curve it faces.
If β > 1, the CB is…
…inflation-averse.
It would trade a small fall in inflation for a large rise in unemployment.
If β < 1, the CB is … : the CB is willing to trade off a given fall in inflation for a small fall in output (and thus a small rise in unemployment). Adjustment in this case takes longer as small reductions in inflations (and hence PC shifts) are achieved each period.
…unemployment-averse
A rise in the unemployment benefit will shift the WS curve …, as it reduces the cost of job loss.
upwards
