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21 Cards in this Set

  • Front
  • Back
Why make the central bank independent?
1. To resist political pressure to decrease unemployment

2. To give incentives to central bankers to take the long view

3. Establish credibility
How does capital taxation relate to time inconsistency?
Say government says they won't tax income from capital, so companies build more factories. However, once this occurs, gov't has an incentive to tax capital and generate more tax revenue.
What are the four main costs of inflation?
1. Shoe-leather costs
2. Tax distortions
3. Money illusion
4. Inflation variability
What are shoe-leather costs?
Costs of making more trips to the bank in the presence of inflation. Increase in the opp. cost of holding money.
What are tax distortions?
Agents become richer in If tax rates aren't changed in order to take into account inflation...nominal income terms but end up paying higher taxes in real terms (if taxes are progressive).
What is money illusion?
The cost of inflation associated with teh notion that people make systematic mistakes in assessing nominal versus real changes leading people to make incorrect decisions.
What is inflation variability?
Financial assets such as bonds, which promise fixed nominal payments in teh future, become riskier.
What are the benefits of inflation?
1. Option of negative real interest rates for macro policy
2. Use of the interaction b/w money illusion and inflation in facilitating real wage adjustments.
3. Seignorage
What is money illusion?
People can't accept a decrease in nominal wage but can accept an increase in nominal wage smaller than inflation.
What is negative real interest rate mean?
Make inflation positive, and decrease nominal interest rates substantially such that r = i + inflation rate produces a negative real interest rate
What is seignorage?
Real revenue gov't generates from money creation, which allow the gov't to borrow less from the public or to lower taxes.

Equal to money growth times real money balances.

Opportunity cost of holding money is the nominal interest rate.
What is debt monetization?
Method used by the gov't to finance its budget deficit-- issue bonds and ask the central bank to buy them. Pays the gov't with the money it creats and the gov't uses that money to finance the deficit.
When expected inflation is very high what will people do with their money?
Try to get rid of it as soon as possible.
What are the effects of an increase in nominal money growth?
Hint: Laffer curve
Inc. real money growth
Inc. inflation
Inc. expected inflation
Decrease nominal interest rate
Decrease real money balances
Decrease seignorage

Depicted in Laffer curve- relationship b/w tax revenues and tax rates
What does the Laffer curve imply?
Hump-shamp shows there's a level of tax that maximizes tax revenue...there's a level of inflation (nominal money growth) that maximizes seignorage.
Why is the inflation tax a regressive tax?
Because the poor hold more of their assets in cash money, thus the inflation rate affects them much more severely than those who are investing. Might in fact lead to hyperinflations.
How do you stop hyperinflation?
Through a stablization program:
1. Fiscal reform and credible budget deficit reduction
2. Taking credible steps that will demonstrate the commitment of the central bank to no longer monetize the debt.
What is the typical inflation target of most central banks today?
Why have central banks strayed away from choosing a target rate for nominal money growth corresponding to the inflation rate they wanted to achieve in the medium run?
Money growth target rule is based on the assumption that a close relation between inflation and nominal money growth exists, however that relation isn't very tight.
What is the Taylor Rule?
Central bank should choose a nominal interest rate rather than a rate of nominal money growth. Target the federal funds rate--the short term interest rate at which banks make loans to one another.
What are the Kaldor stylized facts?
1. Output per head grows over time
2. Capital per head grows over time
3. Capital/output ration roughly constant
4. Real return to capital roughly constant
5. Labor and capital income shares roughly constant
6. Growth of output per head differ across countries