8 - Managing Inflation Expectation

Question 1

Why do politicians generally prefer expansionary monetary policy?

Answer 1

By reducing r, outputs increase increasing the “feel good” in the economy, improving political support.

Question 2

Based on the fact that governments generally prefer expansionary MP, where does the GR lie relative to the MR function?

Answer 2

Higher.

At any given rate of inflation, they prefer higher output.

Question 3

Draw the effects of government control over interest rates.

Answer 3

Question 4

Advantages of anchored inflation expectations.

Answer 4

• Business cycles are less costly with anchored expectations
• Deflation trap is less likely to operate (PC does not shift)

Question 5

What do anchored expectations require?

Answer 5

Must be a belief that the government can keep inflation roughly at the target, otherwise people change their targets to be adaptive.

Question 6

What is the political business cycle?

Answer 6

Government using their GR function to target a higher output rate with higher inflation, but for governmental reasons, it’s worthwhile doing.

Question 7

What is the government loss function at a given π^T?

Answer 7

L^G = (y_t-y_H)²+β(π_t-π^T)²

Slightly differs from CB Loss as y_H rather than y^e.

Question 8

What is the equation for inflation bias?

Answer 8

(y_H-y^e)/αβ

Question 9

How can you get rid of inflation bias?

Answer 9

By having a CB control interest rates rather than a government.