Chapter 23: Monetary Policy Theory

Question 1

inflation target

Answer 1

used to maintain inflation and is slight above zero

Question 2

inflation gap

Answer 2

the difference between inflation and inflation target

Question 3

aggregate demand shock and MP

Answer 3

Fed is able to target price stability and economic stability

Question 4

permanent supply shocks and MP

Answer 4

Fed is able to target price stability and economic stability

Question 5

temporary supply shocks and MP

Answer 5

Fed is only able to target price stability or economic stability

Question 6

aggregate demand shock no policy

Answer 6

SR: change in Y and inflation
LR: shift in AS which only affects inflation

Question 7

aggregate demand shock with policy

Answer 7

SR: change in Y and inflation
LR: shift in AD which returns it to normal

Question 8

permanent supply shock no policy

Answer 8

SR: change in Y and inflation
LR: AS shifts to LRAS which changes Y and inflation even more

Question 9

permanent supply shock with policy

Answer 9

SR: change in Y and inflation
LR: inflation returns to target and Y is at new potential

Question 10

temporary supply shock no policy

Answer 10

SR: change in Y and inflation
LR: AD shifts so Y and inflation returns to normal

Question 11

temporary supply shock with policy

Answer 11

SR: change in Y and inflation
LR: AD shifts so either inflation returns or output returns, but not both

Question 12

divine coincidence

Answer 12

when no conflict exists between the dual objectives of stabilizing inflation and economic activity

Question 13

nonactivists

Answer 13

• believe wages and prices are flexible
• self-correcting mechanisms work fast
• government action is unnecessary

Question 14

activists/Keynesians

Answer 14

• self-correcting mechanism are slow
• government should purse active policies

Question 15

data lag

Answer 15

the time it takes for policymakers to obtain the data

Question 16

recognition lag

Answer 16

the time it takes for policymakers to feel confident about the signals the data are sending about future course of the economy

Question 17

legislative lag

Answer 17

the time it takes to get legislation passed to implement a particular policy (fiscal)

Question 18

implemntation lag

Answer 18

the time it takes for policymakers to change policy instruments once they have decided on a new policy
- specifically fiscal policies

Question 19

effectiveness lag

Answer 19

the time it takes for the policy to have a real impact on the economy

Question 20

Inflation and policymakers

Answer 20

1. monetary authorities can target any inflation rate in the LR with autonomous MP adjustments
2. potential output is independent of monetary policy

Question 21

types of inflation

Answer 21

• cost push inflation
• demand pull inflation

Question 22

cost push inflation

Answer 22

results from a temporary negative supply shock or push by workers for wage increases that are beyond justified by productivity gains

Question 23

demand pull inflation

Answer 23

results when policymakers pursue policies that increase aggregate demand

Question 24

cost push vs demand pull inflation

Answer 24

cost push - unemployment is above natural level
demand pull - unemployment is below natural level

Question 25

self-correcting mechanism at zero lower bound

Answer 25

1. self-mechanism is no longer operational
2. economy goes into deflationary spiral by continually falling inflation and output
   - Y < Yp => pi falls => r rises => Y falls …

Question 26

Nonconventional MP

Answer 26

liquidity provision, asset purchases, and management of expectations

Question 27

zero lower bound and liquidity provision

Answer 27

increases leading facilities to shift AD to the right

Question 28

zero lower bound and asset purchases

Answer 28

lowers credit spreads to shift AD to the right, but if wrong assets are purchased there can be a minimal effect on the economy

Question 29

zero lower bound and management of expectations

Answer 29

forward guidance to shift AS to the left, but if not credible, this will not work