ECON 2035 Chapter 16 The Conduct of Monetary Policy: Strategy and Tactics

Estimates suggest that, in the United States economy, it takes just over ________ for monetary policy to affect output and just over ________ for monetary policy to affect the inflation rate.

1 year; 2 years

Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be

1%

The "Greenspan doctrine" - central banks should not try to prick bubbles - was based on which of the following arguments?

A) Asset-price bubbles are nearly impossible to identify. B) Monetary actions would be likely to affect asset prices in general, rather than the specific assets that are experiencing a bubble. C) Raising interest rates has often been found to cause a bubble to burst more severely. D) Monetary policy actions to prick bubbles can have harmful effects on the aggregate economy.

Lessons that economists and policy makers have learned from the recent global financial crisis include

A) Developments in the financial sector have a far greater impact on economic activity than was earlier realized. B) The zero lower bound on interest rates can be a serious problem. C) The cost of cleaning up after a financial crisis is very high. D) Price and output stability do not ensure financial stability.

The problems of raising the level of the inflation target include

A) if the zero-lower-bound problem is rare, then the benefits of a higher inflation target are not very large. B) the costs of higher inflation in terms of the distortions it produces in the economy are high. C) it is more difficult to stabilize the inflation rate at a higher targeting level.

Suppose interest rates are kept very low for a long time such that there is a spike in the amount of lending. Everything else held constant, this could cause ________ bubble.

a credit-driven

A central bank has ________ chance to identify a credit-driven bubble compared to an irrational exuberance bubble.

a greater

A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor.

a nominal

The decision by inflation targeters to choose inflation targets ________ zero reflects the concern of monetary policymakers that particularly ________ inflation can have substantial negative effects on real economic activity.

above; low

Having interest rate stability

allows for less uncertainty about future planning

International policy coordination refers to

central banks adopting policies in pursuit of joint objectives

Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries.

increase; less

The Fed operating procedures employed between 1979 and 1982 resulted in ________ swings in the federal funds rate and ________ swings in the M1 growth rate.

increased; increased

According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should be ________ by ________ than the inflation rate increase.

increased; more

The time-inconsistency problem with monetary policy tells us that, if policymakers use discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule.

inflation rate

The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is

inflation targeting

During the 1950s, Fed monetary policy targeted

interest rates

Although the Fed professed employment of a monetary aggregate targeting strategy during the 1970s, its behavior suggests that it emphasized

interest-rate targeting

The Federal Reserve has been ________ preemptive because of the changing view that monetary policy has to be ________ looking.

more; forward

The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the

natural rate level of unemployment

The fluctuations in both money supply growth and the federal funds rate during 1979-1982 suggest that the Fed

never intended to target monetary aggregates

If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because

of fluctuations in the demand for reserves

The time-inconsistency problem in monetary policy can occur when the central bank conducts policy

on a discretionary, day-by-day basis

During World War II, the Fed in effect relinquished its control of monetary policy through its policy of

pegging interest rates

The type of monetary policy regime that the Federal Reserve has been following in recent years can best be described as

policy with an implicit nominal anchor

Monetary policy is considered time-inconsistent because

policymakers are tempted to pursue discretionary policy that is more expansionary in the short run

The primary goal of the European Central Bank is

price stability

Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the ________.

price stability; long run

The Fed's use of the federal funds rate as an operating target in the 1970s resulted in

procyclical monetary policy

In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be

procyclical, destabilizing the economy

A borrowed reserves target is ________ because increases in income ________ interest rates and discount loans, causing the Fed to ________ the monetary base, everything else held constant.

procyclical; increase; increase

The Federal Reserve System was created to

promote financial market stability

The Fed's mistakes of the early 1930s were compounded by its decision to

raise reserve requirements in 1936-1937

The Fed can engage in preemptive strikes against a rise in inflation by ________ the federal funds interest rate; it can act preemptively against negative demand shocks by ________ the federal funds interest rate.

raising; lowering

Due to the lack of timely data for the price level and economic growth, the Fed's strategy

uses an intermediate target, such as an interest rate

In the 1970s, the Fed selected an interest rate as an operating target rather than a reserve aggregate primarily because it

was still very concerned with achieving interest rate stability

Supply-side economic policies seek to

increase saving and investment using tax incentives

The real bills doctrine was the guiding principle for the conduct of monetary policy during the

1910s

The Fed accidentally discovered open market operations in the early

1920s

Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be

6.5%

Which of the following is not an element of inflation targeting?

An information-inclusive approach in which only monetary aggregates are used in making decisions about monetary policy

Which of the following is NOT an argument against using monetary policy to prick asset-price bubbles?

Even though credit-drive bubbles are easier to identify, they are still relatively hard to identify

Which of the following is not a disadvantage of of the Fed's "just do it" approach to monetary policy?

It relies on a stable money-inflation relationship

The first country to adopt inflation targeting was

New Zealand

In both New Zealand and Canada, what has happened to the unemployment rate since the countries adopted inflation targeting?

The unemployment rate has declined substantially after a sharp increase

Which of the following criteria need not be satisfied for choosing a policy instrument?

The variable must be transportable

Which of the following is not an advantage of inflation targeting?

There is an immediate signal on the achievement of the target

Targeting interest rates can be procyclical because

an increase in income increases interest rates, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income

A credit-driven bubble arises when ________ in lending causes ________ in asset prices which can cause ________ in lending.

an increase; an increase; a further increase

Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate if the Fed targets

an interest rate

________ bubble is driven entirely by unrealistic optimistic expectations.

an irrational exuberance

A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal

anchor

When asset prices increase above their fundamental values it is called an

asset-price bubble

If the central bank pursues a monetary policy that is more expansionary than what firms and people expect, then the central bank must be trying to

boost output in the short run

Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an operating target.

borrowed reserves

The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American competitiveness, putting pressure on the Fed to pursue a more ________ monetary policy.

decrease; expansionary

Inflation targets can increase the central bank's flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations.

demand; loosen

Inflation results in

difficulty interpreting relative price movements

Which of the following is not an operating instrument?

discount rate

The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate.

dual

The Fed was committed to keeping interest rates low to assist Treasury financing of budget deficits

during World War I and World War II

High inflation can spiral out of control when

expected inflation increases nominal interest rates, causing the Fed to buy bonds, increasing the money supply and further increasing inflation

If the Taylor Principle is not followed and nominal interest rates are increased by less than the increase in the inflation rate, then real interest rates will ________ and monetary policy will be too ________.

fall; loose

Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the

federal funds interest rate

Since the early 1990s, the Fed has conducted monetary policy by setting a target for the

federal funds rate

The Fed's use of the ________ as an operating target in the 1970s resulted in ________ monetary policy.

federal funds rate; procyclical

When it comes to choosing an policy instrument, both the ________ rate and ________ aggregates are measured accurately and are available daily with almost no delay.

federal funds; reserve

Which of the following is not a requirement in selecting a policy instrument?

flexibility

If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand are prevalent,

fluctuations of nonborrowed reserves will be large

When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called

frictional unemployment

The mandate for the monetary policy goals that has been given to the European Central Bank is an example of a ________ mandate.

hierarchical

Which set of goals can, at times, conflict in the short run?

high unemployment and price level stability

When compared to the Fed's ________ anchor approach, ________ targeting can make the institutional framework for the conduct of monetary policy more consistent with democratic principles.

implicit; inflation

The Fed accidentally discovered open market operations when

it purchased securities for income following the 1920-1921 recession

A nominal anchor promotes price stability by

keeping inflation expectations low

The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to

let interest rates increase

The most common definition that monetary policymakers use for price stability is

low and stable inflation

During World War II, whenever interest rates would rise and the price of bonds would begin to fall, the Fed would

make open market purchases of government securities

Although the Fed professed employment of ________ targeting during the 1970s, its behavior suggests that it emphasized ________ targeting.

monetary aggregate; interest-rate

During the 1950s, the Fed targeted

money market conditions

In practice, the Fed's policy of targeting ________ in the 1960s proved to be ________, destabilizing the economy.

money market conditions; procyclical

Everything else held constant, a credit-drive bubble is generally considered to have the potential to cause ________ damage to an economy compared to an irrational exuberance bubble.

more

In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary policy was known as the

real bills doctrine

The guiding principle for the conduct of monetary policy that held that as long as loans were being made for "productive" purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the

real bills doctrine

Real interest rates are difficult to measure because

real interest rates depend on the hard-to-determine expected inflation rate

Economists believe that countries recently suffering hyperinflation have experienced

reduced growth

High unemployment is undesirable because it

results in a loss of output

During World War II, whenever interest rates would ________ and the price of bonds would begin to ________, the Fed would make open market purchases.

rise; fall

According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation ________ the Fed's inflation target or when real GDP ________ the Fed's output target.

rises above; rises above

Unemployment resulting from a mismatch of workers' skills and job requirements is called

structural unemployment

Even if the Fed could completely control the money supply, monetary policy would have critics because

the Fed is asked to achieve many goals, some of which are incompatible with others

The monetary policy strategy that provides the least accountability is

the implicit nominal anchor

The monetary policy strategy that suffers a lack of transparency is

the implicit nominal anchor

Which of the following is a potential operating instrument for the central bank?

the monetary base

The rate of inflation tends to remain constant when

the unemployment rate equals the NAIRU

The rate of inflation increases when

the unemployment rate is less than the NAIRU

Which of the following is not a disadvantage to inflation targeting?

there is a lack of transparency

The ________ problem of discretionary policy arises because economic behavior is influenced by what firms and people expect the monetary authorities to do in the future.

time-inconsistency

The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor long-run outcomes is referred to as the

time-inconsistency problem