L5 Monetary Policy Rules

Question 1

MP at one point assumed to be horizontal, but we want to endogenise monetary policy as the CB wont just sit there when the government is doing something. How do we do that? What’s the rule called?

When does the MP become upward sloping?

Answer 1

Build the reaction function
Allowing the MP curve to respond to both pi and Y

Taylor rule!
R = r + m^pi^ (pi - pit) + m^Y^(Y -Y*)

MP becomes upward sloping when R feeds back on Y. MP curve as sensitive as CB wants

Question 2

Case against active monetary policy

Answer 2

Long and variable lags
Inside - time from shock hitting to policy change
Outside - time from change in policy to effects being felt

Question 3

Case for active monetary policy

Answer 3

Hard to estimate policy lags
Success in policy activity eg Great Moderation
What does it mean to control M?

Friedman said to control M; can use money supply growth to control inflation via QTM
MV = PY as g(y) fixed, g(v) is zero.

Via Fisher wanted to grow m so that pi=-r