Chapter 14: The Conduct of Monetary Policy: Spring 2016 Final Review.

(Chapter 14) 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 exchange markets

Criteria for Choosing the Policy Instrument

* Observability and Measurability * Controllability * Predictable effect on Goals

(Chapter 14) Difference between rule based monetary policy / versus / discretionary monetary policy

* monetary policy rule will "greatly improve transparency and predictability," *make decisions on interest rates on a case-by-case basis instead of allowing a set rule.

Lessons for Monetary Policy Strategy from the Global Financial Crisis

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

(Chapter 14) When comparing the monetary base to M1 on the grounds of controllability and​ measurability, why would you prefer the monetary base as an intermediate​ target?

1. The monetary base is more directly influenced by the tools of the Fed. 2. The Fed can calculate data on the monetary base from its own balance sheet​ data, while it constructs M1 numbers from surveys of​ banks, which take some time to collect and are not always that accurate. 3. The monetary base is measured more accurately and quickly.

(Chapter 14) 1. The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom. 2. Public announcement of medium-term numerical target for inflation Institutional commitment to price stability as the primary, long-run goal of monetary policy and a commitment to achieve the inflation goal

1. inflation targeting

(Chapter 14) inflation targeting Advantages / Disadvantages

Advantages: Does not rely on one variable to achieve target Easily understood Reduces potential of falling in time-inconsistency trap Stresses transparency and accountability Disadvantages: Delayed signaling Too much rigidity Potential for increased output fluctuations Low economic growth during disinflation

(Chapter 14) "Just Do it approach" Advantages / Disadvantages

Advantages: forward-looking behavior and stress on price stability also help to discourage overly expansionary monetary policy, thereby ameliorating the time-inconsistency problem. Disadvantages: lack of transparency; strong dependence on the preferences, skills, and trustworthiness of the individuals in charge of the central bank

(Chapter 14) A nominal anchor promotes price stability by A) outlawing inflation. B) stabilizing interest rates. C) keeping inflation expectations low. D) keeping economic growth low.

C) keeping inflation expectations low.

(Chapter 14) 1) The most common definition that monetary policymakers use for price stability is A) low and stable deflation. B) an inflation rate of zero percent. C) high and stable inflation. D) low and stable inflation.

D) low and stable inflation.

(Chapter 14) ​"Interest rates can be measured more accurately and quickly than reserve​ aggregates; hence an interest rate is preferred to the reserve aggregates as a policy​ instrument." Do you agree or​ disagree?"

Disagree. The measurement of real interest rates requires estimates of expected​ inflation, and it is not true that real interest rates are necessarily measured more accurately and quickly than the money supply.

Phillips curve:

Displays no long-run trade off between unemployment and inflation. Expected inflation rises, shifting the PC curve upward. Finally, the Phillips curve reaches unemployment natural rate. The shift of unemployment shifting toward 10% is the natural rate.

(Chapter 14) Aimed to achieve two coequal objectives: price stability and maximum employment (output stability

Dual mandates

(Chapter 14) Put the goal of price stability first, and then say that as long as it is achieved other goals can be pursued

Hierarchical mandates

How does the Central bank make the choice of a monetary policy instrument ?

Interest rate at which banks borrow and lend monetary base overnight

(Chapter 14) Ties down the price level to achieve price stability

Nominal Anchor

Using the demand and supply analysis , How would the Federal Reserve target either the non-borrowed reserves(NBR) or the federal funds rate

Non-borrowed reserves (NBR) Target : Targeting on non borrowed reserves of NBR' will lead to fluctuations in the federal funds rate between iff' and iff'' because of fluctuations in the demand for reserves between Rd' and Rd'' Federal Funds Target : Targeting on the interest rate i*ff will lead to fluctuations in non-borrowed preservers between NBR' and NBR'' because fluctuations in the demand for reserves is between Rd' and Rd''

(Chapter 14) What procedures can the Fed use to control the federal funds​ rate?

Open market operations

(Chapter 14) Why does control of this interest rate imply that the Fed will lose control of non-borrowed​ reserves?

The Fed has to adjust reserves in response to changes in reserve demand to keep interest rates at the target.

(Chapter 14) If the Fed has an​ interest-rate target, why will an increase in the demand for reserves lead to a rise in the money​ supply? If i*ff is the​ interest-rate target (R1d to R2d shifts up) , what can the Fed do to keep the federal funds rate near its​ target?

The Fed will conduct open market purchases.

(Chapter 14) The Federal Reserve's Monetary Policy Strategy "Just Do it approach"

There is no explicit nominal anchor in the form of an overriding concern for the Fed. Forward looking behavior and periodic "preemptive strikes" The goal is to prevent inflation from getting started.

(Chapter 14) Is this statement​ true, false, or​ uncertain? Explain your answer."If the demand for reserves did not​ fluctuate, the Fed could pursue both a reserves target and an​ interest-rate target at the same​ time."

True. The target interest rate would have a set level of reserves that would only change if the Fed desired.

Federal Funds rate =

[inflation rate] + [Equilibrium real federal funds rate] + 1/2 ([Inflation GAP]) + 1/2 ([Output GAP]) If GDP is given, ie: GDP is 1% above potential (+1) to Federal funds rate. ie: GDP is 1% below potential (-1) to Federal funds rate.

(Chapter 14) The fed funds rate is _______________

a policy instrument because it can be directly affected by the tools of the Fed.

(Chapter 14) The monetary base is _______

a policy instrument because it is affected by the​ Fed's monetary policy tools and does not have a direct effect on economic activity.

(Chapter 14) The​ ten-year Treasury bond rate is _______

an intermediate target because it is affected by the​ Fed's monetary policy tools and has a direct effect on economic activity.

(Chapter 14) M1 is ___________

an intermediate target because it is not affected by the​ Fed's monetary policy tools and has a direct effect on economic activity.

The NAIRU is the rate of unemployment at which

the inflation rate is constant *When the unemployment rate is above NAIRU, then output below potential, inflation will fall, *When the unemployment rate is below NAIRU, with output above potential, inflation will rise.

(Chapter 14)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.