Los 15.c Flashcards
(5 cards)
What are the three essential qualities a central bank must have to succeed in inflation targeting?
Independence: The central bank must be free from political influence to make decisions that might decrease economic growth or employment in the short term for long-term price stability. Independence from Politians.
Credibility: A central bank’s ability to follow through on its stated goals is vital for market confidence. If the market trusts the central bank, inflation expectations will align with the target. Businesses and consumers will make decisions based on that expectation.
Transparency: The central bank should regularly disclose its economic assessments and how it sets monetary policy. This transparency helps the market anticipate decisions leading to more effective monetary policy.
What is exchange rate targeting, and how does it differ from inflation targeting?
Exchange rate targeting involves setting a fixed exchange rate between the domestic currency and another currency (often the U.S. dollar). If the value of the domestic currency moves too far from the target, the central bank buys or sells its currency to bring it back in line. Unlike inflation targeting, this focuses on stabilizing the currency value rather than controlling inflation.
What is the typical inflation target for most central banks? Why not target 0% inflation?
Most central banks target an inflation rate of 2% (with a ±1% range). A 0% target could lead to deflation, which is harmful for the economy because it may result in falling prices, lower demand, and reduced economic activity.
What are the limitations of monetary policy?
Monetary policy transmission can be unpredictable, especially for long-term interest rates, which may not always respond as expected.
A liquidity trap occurs when people prefer holding cash rather than investing, which makes monetary policy less effective.
Deflation can limit monetary policy effectiveness, especially when interest rates are already near zero.
What is QE, when is it used, and what challenges does it bring?
QE is used when traditional monetary policy tools (like lowering interest rates) are not sufficient. It involves the central bank buying long-term securities, such as government bonds, to increase liquidity in the financial system. It was used during and after the 2008 financial crisis to encourage lending and stimulate economic activity.
Even though QE injects money into the economy, banks may not lend the excess reserves because of uncertainty or risk aversion. This can limit QE’s effectiveness in stimulating economic growth.
