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119 Cards in this Set
- Front
- Back
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Overly Monetary Expansion leads to... |
high inflation |
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Monetary policy that is too tight can produce... |
serious recessions in which output falls and unemployment rises |
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One of the most important strategies for the conduct on monetary policy |
inflation targeting |
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central banks describe this as low and stable inflation |
price stability |
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inflation leads to... |
lower economic growth |
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a nominal variable, such as the inflation rate or the money supply that ties down the price level to achieve price stability |
nominal anchor |
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monetary policy conducted on a discretionary, day-by-day basis leads to poor long-term outcomes |
time-inconsistency problem |
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Even if a central bank recognizes that discretionary policy will lead to a poor outcome, it still may not be able to pursue the better policy of inflation control because... |
politicians are likely to apply pressure on the central bank to try to boost output with overly expansionary monetary policy
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A nominal anchor can help prevent the time-inconsistency problem in monetary policy by... |
providing an expected constraint on discretionary policy. |
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Five other goals are continually mentioned by central bank officials when they discuss the objectives of monetary policy: |
1. high employment and output stability 2. economic growth 3. stability of financial markets 4. interest-rate stability 5. stability in foreign markets |
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Two reasons that high employment is a worthy goal |
1. the alternative situation causes much human misery 2. When unemployment is high, the economy has both idle workers and idle resources, resulting in a loss of output |
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involves searches by workers and firms to find suitable match-ups |
frictional unemployment |
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What does frictional unemployment mean to the economy? |
it's beneficial |
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a mismatch between job requirements and the skills of availability of local workers |
structural unemployment |
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the point at which the demand for labor equals the supply for labor |
natural rate of unemployment |
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Current estimates of the natural rate of unemployment place it between... |
4.5 and 6% |
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A particular level of output is produced at the natural rate of unemployment called... |
natural rate of output |
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Another name for natural rate of output |
potential output |
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Trying to achieve the goal of high employment means that central banks should... |
try to move the level of output toward the natural rate of output |
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The goal of steady economic growth is closely relate to the high employment goal because... |
businesses are more likely to invest in capital equipment to increase productivity and economic growth when unemployment is low. |
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Are intended to spur economic growth by providing tax incentives for businesses to invest in facilities and equipment and for taxpayers to save more |
supply side economics |
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Financial crises can... (2) |
interfere with the ability of financial markets to channel funds to people with productive investment opportunities lead to a sharp contraction in economic activity |
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The Federal Reserve System was created... |
to promote financial stability in the wake of the bank panic of 1907 |
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Why is interest-rate stability desirable? |
because fluctuations in interest rates can create uncertainty in the economy and make it harder to plan for the future |
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Fluctuations in interest reates create... |
great uncertainty for financial institutions |
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A rise in the value of the dollar makes American industries... |
less competitive with those abroad |
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A drop in the value of the U.S. dollar.... |
stimulates inflation in the U.S. |
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There is no... |
long-run trade off between inflation and employment |
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In the Short-run, price stability often... |
conflicts with the goals of output stability and interest-rate stability |
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put the goal of price stability first and then state other goals can be pursued as long as price stability is achieved |
hierarchal mandates |
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The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain... |
long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production |
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Why does the BoG and FRS maintain long run growth of the monetary and credit aggregates? |
to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates |
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achieves two coequal objectives |
dual mandate |
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What two objectives does the dual mandate achieve? |
price stability and maximum employment |
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These two objectives are not very different if... |
maximum employment is defined as the natural rate of employment |
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Because low and stable inflation rates promote economic growth, central bankers have come to realize that... |
price stability should be the primary, long-run goal of monetary policy. |
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As long as price stability is a long-run, but not short-run goal, central banks can focus on... |
reducing output fluctuations by allowing inflation to deviate from the long-run goal for short periods and can operate under a dual mandate. |
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Deciding which type of mandate is better for a central bank ultimately depends on... |
the subtleties of how the mandate will work in practice |
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Inflation Target involves several elements (5) |
1. public announcement of medium-term targets for inflation. 2. an institutional commitment to price stability as the primary, long-run goal of monetary policy and a commitment to achieving the inflation goal 3. an information-inclusive approach in which many variables are used in making decisions about monetary policy 4. increased transparency policy strategy through communication with the public and the markets about the plans and objectives of monetary policymakers 5. increased accountability of the central bank for attaining its inflation objectives |
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An unusual feature of the New Zealand legislation is that... |
the Board of Governor of the Reserve Bank is held highly accountable for the success of monetary policy |
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There are a number of benefits associated with inflation targeting: (5) |
1. reduction of the time-inconsistency problem 2. increased transparency 3. increased accountability 4. consistency with democratic principles 5. improved performance |
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A key advantage of inflation targeting is that it can... |
help focus the political debate on what a central bank can do in the long run rather than what it cannot do |
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What can't the central bank do? |
permanently increase economic growth and the number of jobs through expansionary monetary policy |
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Inflation target has the advantage that it is... |
readily understood by the public and is thus highly transparent |
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The channels of communication used by central banks in inflation-targeting countries explain the following concepts to the general public, financial market participants, including the rationale and politicians: (4) |
1. the goals and limitations of monetary policy 2. the numerical values of the inflation targets 3. how the inflation targets are to be achieved 4. reasons for any deviations from the targets |
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Transparency and Communication... |
go hand in hand with increased accountability |
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Not only is accountability valuable in its own right, but it also makers... |
the institutional framework for the conduct of monetary policy more consistent with democratic priniciples |
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The performance of inflation-targeting regimes has been... |
quite good. |
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Inflation-targeting countries seem to have significantly reduced... |
both the rate of inflation and inflation expectations beyond what likely would have occurred in the absence of inflation targets. |
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Critics of inflation targeting cite four disadvantages of this monetary policy strategy: |
1. too much rigidity 2. the potential for increased output fluctuations 3. low economic growth 4. delayed signaling |
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An inflation target does not send... |
immediate signs to the public and markets about the stance of monetary policy. |
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Inflation target does not prescribe... |
simple and mechanical instructions on how the central banks should conduct monetary policy |
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Inflation targeting contains... |
a substantial degree of policy discretion. |
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Inflation targeting does not ignore... |
traditional stabilization goals. |
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Although inflation reduction has been associated with... |
below normal output during discretionary phases in inflation-targeting regimes. |
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Once low inflation levels were achieved, output and employment... |
returned to levels at least as high as they were before. |
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Monetary policy effects have... |
long lags |
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If a central bank waits until signs of inflation appear, it will be.... |
too late to maintain stable prices without a severe tightening of policy |
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Inflation expectations will already be... |
embedded in the wage- and price-setting process, creating an inflation momentum that will be hard to halt |
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To prevent inflation from getting started, monetary policy needs to be... |
forward looking and preemptive |
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monetary policy needs to act long before... |
inflationary pressures are seen in the economy |
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Low accountability might also make the Fed more susceptible to the... |
time-inconsistency problem, whereby it might pursue short-term objectives at the expense of long-term ones. |
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The global financial crisis suggests four basic lessons for economists and policymakers on how the economy works: |
1. Developments in the financial sector have a far greater impact on economic activity than was earlier realized. 2. The zero lower bound on interest rates can be a serious problem. 3. The cost of cleaning up after a financial crisis is very high. 4. Price and output stability do not ensure financial stability. |
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The zero lower bound on the policy rate would be less binding with... |
a higher inflation target. |
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pronounced increases in asset prices that depart from fundamental values and that eventually burst resoundingly |
asset price bubbles |
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Asset-price bubbles are of two types: |
1. driven by credit 2. drive purely by overly optimistic expectations |
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What is the feedback loop for credit driven bubbles? |
A credit boom drives up asset prices, which in turn fuels the credit boom, which drives up asset prices higher, etc. |
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What happens when there was a credit driven bubble and it bursts?
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the collapse in asset prices leads to a reversal of the feedback loop |
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What is the reversal of the feedback loop? |
loans go sour lenders cut back on the credit supply the demand for assets decline further prices drop even more |
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Bubbles that are driven solely by overly optimistic expect ions pose... |
much less risk to the financial system |
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What are the two ways you could pop bubbles? |
leaning against asset-price bubbles vs. cleaning up after the bubble burst |
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Why Central Banks should not try to prick asset bubbles but should just clean up after they burst: (5) |
1. Asset price bubbles are nearly impossible to identify. 2. Although some economic analysis suggests that raising interest rates can diminish asset price increases, raising interest rates may be very ineffective in restraining bubbles, because market participants expect such high rates of return from buying bubble-driven assets. 3. Many different asset prices exist, and at any one time a bubble may be present in only a fraction of asset. 4. Monetary policy actions to prick bubbles can have harmful effects on the aggregate economy. 5. As long as policymakers respond in a timely fashion by easing monetary policy aggressively after an asset bubble bursts, the harmful effects of a bursting bubble can be kept at a manageable level. |
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The recent financial crisis clearly demonstrated that the bursting of credit-driven bubbles can be... |
not only extremely costly but also very hard to clean up. |
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The case is much stronger for leaning against credit booms, which would involve... |
leaning against credit-drive asset-price bubbles but not against asset-price bubbles driven by irrational exuberance. |
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The key principle to consider in designing effective policies to lean against credit booms is that... |
such policies must curb excessive risk taking. |
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regulatory policy to affect what is happening in credit markets in the aggregate |
macroprudential regulation |
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Financial regulation and supervision can prevent... |
the excessive risk taking that can trigger a credit boom, which in turn will lead to an asset-price bubble. |
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Regulation should focus on... |
preventing leverage cycles |
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A rapid rise in prices accompanied by a credit boom provides... |
a signal that market failures or poor financial regulation and supervision might be causing a bubble to form. |
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Overly easy monetary policy might promote... |
financial instability |
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Low interest rates may increase the incentives for asset managers in financial institutions to.. |
search for higher yields and hence increase risk taking |
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Prudential supervision is subject to more political pressure than monetary policy because... |
it affects the boom line of financial institutions more directly. |
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An important lesson from the global financial crisis is that central banks and other regulators should not have... |
a laissez faire attitude and let credit-driven bubbles proceed without any reaction. |
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To ascertain whether policy is easy or tight, we can observe the... |
policy instrument |
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variable that responds to the central bank's tools and indicates the stance of monetary policy |
policy instrument |
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another name for a policy instrument |
operating instrument |
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A central bank like the Fed has at its disposal to basic types of policy instruments: |
reserve aggregates interest rates |
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What are reserve aggregates? (4)
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total reserves non borrowed reserves the monetary base the non borrowed base |
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What are two types of interest rates? |
the federal funds rate other short-term interest rates |
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stand between the policy instrument and the goals of monetary policy |
intermediate target |
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Two examples of intermediate targets |
monetary aggregate like M2 or a long-term interest rate |
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Intermediate targets are not as directly affected by the tools of monetary policy, but might be... |
more closely linked to the goals of monetary policy |
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The Central bank's adherence to the interest-rate target leads to... |
a fluctuating quantity of non borrowed reserves and the money supply. |
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Interest-rate and reserve aggregate targets are... |
incompatible |
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Three criteria apply when choosing a policy instrument: |
1. the instrument must be observable and measurable 2. it must be controllable by the central bank 3. it must have a predictable effect on the goals |
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Quick observability and accurate of a policy instrument are necessary because... |
such an instrument is useful only if it signals the policy stance rapidly |
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Interest rates are more observable and measurable than reserves and are... |
a better policy instrument. |
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The interest rate that is easiest to measure and observe is... |
the nominal interest rate |
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The real cost of borrowing is more accurately measured by... |
the real interest rate |
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What is the real interest rate? |
the nominal interest rate adjusted for expected inflation |
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A central bank must be able to exercise effective control over a variable if the variable is to... |
function as a useful policy instrument |
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The Fed can control short-term interest rates... |
very tightly |
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What is a short-term interest rate? |
The Federal Funds Rate |
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A central bank cannot set... |
short-term real interest rates because is does not have control over expectations of inflation |
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Most central banks have concluded that the link between interest rates and goals such as stable inflation is... |
stronger than the link between aggregates and inflation |
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Central banks throughout the world now generally use... |
short-term interest rates as their policy instrument. |
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The Taylor rule indicates that the... |
federal funds rate should be set equal to the inflation rate plus an equilibrium real fed funds rate plus a weighted average of two gaps. |
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What are the two gaps |
an inflation gap an output gap |
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what is the inflation gap? |
current inflation minus a target rate |
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What is an output gap? |
the percentage deviation of real GDP from an estimate of its potential (natural rate) level. |
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What is the Taylor Rule in words? |
Federal Funds rate Target = inflation rate + equilibrium real fed funds rate + 1/2 (inflation gap) + 1/2 (output gap) |
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An important feature of the Taylor rule is that the coefficient of the inflation gap is... |
positive. |
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The principle that the monetary authorities should raise nominal interest rates by more than the increase in the inflation rate |
The Taylor Principle |
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Caring about inflation and output fluctuations is consistent with the Fed's... |
dual mandate and with many statements by Federal Reserve officials that controlling inflation and stabilizing real output are important concerns of the Fed. |
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states that the changes in inflation are influenced by the state of the economy relative to its productive capacity as well as by other factors |
Philips Curve Theory |
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A related concept to the Philips Curve is the... |
Nonaccelerating Inflation Rate of Unemployment |
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the rate of unemployment at which there is no tendency for inflation to change |
NAIRU |
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Philips Curve Theory is now... |
highly controversial. |
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Critics question whether the Philips Curve Theory should be used as...
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a guide in the conduct of monetary policy. |
