Monetary Policy: Definitions/Concepts

Question 1

Stagflation

Answer 1

A combination of inflation and high and

persistent unemployment

Question 2

The monetary transmission mechanism

Answer 2

The process through which a central bank’s
monetary policy decisions affect the economy in general, and the ultimate target variables (price level, output, employment,…) in particular

Question 3

Interest rate channel

Answer 3

Monetary policy affects a range of interest rates and this then affects investment and consumption decisions of companies and households

Question 4

Asset price channel

Answer 4

Monetary policy decisions affect asset prices (given the negative relationship between asset prices and interest rates), which in turn affects demand through wealth effects and relative price effects (

Question 5

Credit channel

Answer 5

Monetary policy affects the supply of bank credit through the change in interest rates and asset prices

Question 6

External channel

Answer 6

Monetary policy affects the exchange rate, which influences the price of imports and exports

Question 7

Discretionary or activist policy

Answer 7

Implies that the stance of monetary policy is regularly
adjusted to prevailing economic conditions. The government can also use fixed rules which are expected to lead to the best results for monetary policy in the long run

Question 8

Fixed Rule

Answer 8

• A fixed rule is, for example, a predetermined growth rate of the money supply

Question 9

Mundell-Fleming Trilemma

Answer 9

Also known as the impossible or inconsistent trinity), countries cannot simultaneously fix their exchange rate, open their capital account (i.e., free capital mobility), and conduct an independent monetary policy.
Only two of the tree are possible