Lent - Lecture 3 - Adding Monetary Policy Flashcards Preview

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Flashcards in Lent - Lecture 3 - Adding Monetary Policy Deck (15)
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1
Q

What are the two monetary policy instruments that central banks set? Which of these is more realistic?

A
  • CB sets money supply M
  • CB sets nominal interest rate, i
2
Q

What is the difference between the Keynesian assumption and the Classical assumption regarding the Fisher effect?

A
  • the crucial Keynesian assumption is that changes to i influence r
  • the classical model assumes changes in i have no effect on r
3
Q

At a given point in time, the central bank has a desired real interest rate, R. Given exogenous π(e), what is the relationship between R, i and π(e)?

A

i = R + π(e)

4
Q

IS-MP gives a unique (r, Y) with:

A
  • goods market equilibrium (A = E in Keynesian Cross)
  • money market equilibrium
5
Q

Define the ‘neutral real interest rate’, r̅

A

r̅ equates S and I when Y = Y̅ and there are no temporary shocks to planned expenditure

6
Q

When R = r̅, short-run policy is consistent with…?

A

short-run policy is consistent with long-run Classical equilibrium

7
Q

Why does there exists a ‘zero’ lower bound on i - at least for consumers?

A
  • i is the nominal rate paid on risk-free assets
  • suppose this were negative
  • then cash dominates as an asset
  • no-one would hold bonds or keep money in the bank
  • so long as cash exists, a ‘zero’ lower bound on i - at least for consumers
8
Q

If there is a zero bound for i, then what does this mean about the value of r

A
  • if there is a zero bound for i, then r is also constrained
  • from the Fisher equation, if i >= 0
  • then, r >= -π(e)
9
Q

Why might the neutral rate, r̅, be unattainable?

A
  • as i >= 0, thus r >= -π(e) (from the Fisher equation)
  • thus a desired real rate R may not be possible if R < -π(e)
  • lower π(e), or expected deflation, is a particular worry (as it makes it more likely that R < -π(e), which is unattainable)
  • thus, even without shocks, the neutral rate r̅ may be unattaianble
10
Q

As the zero-lower-bound means that the desired output level may be unattainable by conventional monetary policy, what other policies could be used?

A
  • unconventional monetary policies, for example
  • quantitative easing
  • forward guidance
11
Q

What is the yield curve?

A

a plot of the nominal interest rate, i, against the borrowing horizon (how long you will be borrowing for)

12
Q

The policy interest rate that central banks control is an overnight i. Which is interest rate that usually matters most for borrowers? Why?

A
  • the interest rates that matter for borrowers are usually more long-term
  • as investment projects take time
13
Q

Define the long-term real interest rate, r(L)

A

the opportunity cost of investment

14
Q

Explain how unconventional monetary policy works, using the fact that I = I(rL) = I(r, θ)

A
  • normally, changes to the overnight i (and r) will pass through into longer-term i (and r)
  • so if π(e) exogenous, policy still influence investment. Changing short-term i changes short-term r, changing short-term r changes long-term rL
  • investment varies in rL: I = I(rL)
  • but other factor will matter for rL, as well as r
  • for instance, expected future monetary policy, long-term vs short-term asset demand
  • thus, we could write rL = rL(r, θ), with θ being ‘other factors’
  • this means I = I(rL) = I(r, θ)
  • so the idea behind unconventional policy is that if r is ZLB-constrained, why not change θ?
15
Q

Briefly summarise how quantitative easing and forward guidance work

A
  • QE: CB buys long-term debt, with the aim of raising its price. Higher price for debt means lower interest rate for the borrower
  • FG: CB promises that short-term rates will be kept low in the future
  • BIG debates about the effectiveness of both