week 8 Flashcards
(25 cards)
historical information about the bank of england?
- founded in 1694
- the oldest central bank is the swedish one established in 1668 => sweden has always been influential in central banking, including the design and implementation of monetary policy
what were the roles of early central banks?
- lend the government funds
- act as a clearing house for commerce
what was the initial purpose of the bank of england?
1) to purchase government debt => lend the government money to fun wars with france
- The lenders (“The Governor and Company of the Bank of England”) gave the government cash
2) the lenders were also given the power to issue notes backed by / against the government bonds they now held (that new cash could then be lent)
3) once it was established the bank of englang held depository of ther banks so served as the bank for bankers, facilitating transactions between banks and providing other banking services
some key point from the video abou thistory of money?
Central bank solves problems that arose with goldsmith-bankers and similar multiple institutions each printing their own banknotes:
* Receipts given for gold/silver; began to be traded; exchangeable with other banks
* But this was not the initial motivation: some central banks were introduced to raise fiscal revenue (often for wars).
* Central banks print money; operate payment systems involving other banks; LOLR.
- LOLR lender of last resort: BoE will lend to/bail out other banks. This can alleviate problems of, and thus prevent, bank runs.
- When a central bank has the fiscal backing of a government/country, trust in the redeem ability of its money is high: CB can’t fail unless the government/country does.
- Early BoE notes traded at a premium.
- 1844 Bank Charter Act: no new bank allowed to print notes.
* 1921: Last English bank to print own notes ceased. - 1946: BoE nationalised (owned by government rather than private stockholders)
- 1998 Bank of England Act: BoE given operational independence (controls instrument; does not set goal)
who created the tim inconsitency model along with real business cycle model?
- finn kydland and edward prescott
- won economics nobel prize in 2004
- the showed that if the policymaker can act with discretion (their choice is not restricted by rules; their hands are not tied; they are not committed to a particular course of action) => outcomes are suboptimal
what is the kydland-prescott model?
- policymakers’ preferences can lead them
to make promises that their incentives will later make it in their interests not to keep - Policymaker actions would be time-inconsistent: their actions under discretion would not be consistent with their promises.
- If this is known, policymaker promises would lack credibility
- everyone – policymaker and public – would be better off if the policymaker could have committed themselves to their original promise, rather than
acting with discretion
what is the barro-gordon model?
- both robert barro and david gordon’s papers in 1983 built on kydland-prescott idea and developed a model of policy decision-making under rational expectations
- the model allows a comparison of the outcomes under discretion and under commitment
- they notes that the formation of expectations was key to the model’s outcome
- the primary interest i son the rational expectations model
- The policymaker can be thought of as the government, to emphasise that it is not an independent central bank
what is discretion to a rule?
- under discretion the polocy maker can decide or act without constraint
- we assume they are motivated to choose actions that they view as best which can be moddlede as in society’s or in their own best inetrest
- The situations we look at can generally be conceived as one-shot games, in which the policymaker would act in their own best short-term interest.
what is commitement to a rule?
how outcomes differ if the policymaker can credibly commit to follow some rule, such as a mandate given to (or laid down in the statutes of) an independent and accountable central bank.
what is the loss function of the barro-gordon model?
what is the inverted phillips curve in the barro-gordon model?
what is policymaking in the barro-gordon model?
what does this mean?
what is the timing and steps of the barro-gordon model?
1) public sets expected inflation - start of t
2) policymaker sets inflation given the expected inflation duting t
3) given the expected inflation and the real inflation, unemployment is determined by the Phillips Curve, giving Lt - at the end of t.
what is the government bliss point at the loss function?
how does the barro-gordon model: loss function looks like?
what does the phillips curve tell us?
- If actual inflation exceeds expectations, unemployment will be lower than the natural rate
- if wage settlements (=nominal wage changes 𝑡) are influenced by (for simplicity, equal to) expected inflation, real wages will fall if inflation𝑡 > expeced inflation = nominal wage chnages, raising labour demand so reducing unemployment.
- b is, then, the sensitivity of unemployment to
real wage changes. - 1/b is the sensitivity of inflation to the “unemployment gap” Ut - Uˆ𝑁.
what is the main policy instrument?
- policy involves choosing inflation t directly
- assumes there is no difficulty selecting a particular inflation rate
- effectively inflation t is the policy instrument
- the government/policymaker choose inflation t to minimise their loss
what is the desired government preference over unemployment?
U* < UˆN
- model assumes that the government prefers unemployment lower than the natural rat
- justification:
1) wants to avoide losing votes of th unemployed
2) government bows to union pressure (reflecting members’ preference) to reduce unemployment
3) economy faces imperfections (advance argument)
what is important about the paramteres a and b?
- both positive, exogenous and time-invariant
what influences the outcome?
how expectations are formed?
what are the different types of expectations?
- naive -> Public (wage-setters) believe inflation will be what the government tells them
- anchored -> Insensitive to incoming data; Extent of anchoring can vary
- Rational -> Forward-looking expectations formed using the correct model of the world
what is the naive solution of the barro-gordon model?
- when the public believs a promise that the policy will be set so that inflation t = inflation * => their expectation becomes : expected inflation = inflation*
- the gov has the incentive to cheat => to renege on the promise and choose inflationt > inflation* since by doing so the government can achieve or get closer to its desired U* < UˆN
why this topic matters?
Governments (or central banks) want low inflation AND low unemployment.
But sometimes, they can’t credibly commit to keeping inflation low — especially when unemployment is above their ideal level.
This leads to the time inconsistency problem: they say one thing (low inflation), but later do another (print more money to reduce unemployment), which ends up making things worse overall.
