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Money and Banking > Week 8 Deck > Flashcards

Week 8 Deck Flashcards

1
Q

What are the nonconventional monetary policies implemented by centrals (4)

A
  1. Liquidity provision
  2. Large scale asset purchases
  3. Forward guidance
  4. Negative interest rates on banks’ deposit
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2
Q

How is price stability defined?

A

Low and stable inflation

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3
Q

What is the nominal anchor and why is it important

A
  • A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve the price stability
  • Nominal anchor can also limit the time-inconsistency problem
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4
Q

Time-inconsistency problem

Why do policy makers attempt to pursue monetary policy that is more expansionary than expected

A
  • This policy would boost economic output (and lower unemployment) in the short run
  • Best policy, however, do not pursue expansionary policy, as this can affect workers and firms expectations about inflation
  • Recall equation 10 from week 7, and assume no inflation shock
    Inflation can be determined by either rational expectations (strong assumption) or adaptive expectations
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5
Q

What is the equation for a nominal anchor?

A

SEE DIAGRAM

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6
Q

What are the 5 other goals of monetary policy?

A
  1. High employment and output stability
    - Natural rate of unemployment
  2. Economic growth
  3. Stability of financial markets
  4. Interest rate stability
  5. Stability in foreign exchange markets
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7
Q

Should price stability be the main goal of monetary policy?

Explain hierarchal versus dual mandates

A
  • Hierarchical mandates put the goal of price stability first, then others can follow
  • Dual mandates are aimed to achieve two coequal objectives: price stability and maximum employment
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8
Q

Explain Inflation targeting in detail

A

• A monetary policy strategy
• Inflation targeting involves a number of essential elements:
- Public announcement of medium-term numerical target for inflation
- Institutional commitment to price stability as the primary, long run goal of monetary policy and a commitment to achieve the inflation goal
- Information-inclusive approach in which many variables are used in decision making
- Increased transparency of the strategy
- Communication to the public and financial markets: media, minutes, reports ets
- Increased accountability of the central bank

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9
Q

Explain the advantages of inflation targeting (5)

A
  • Does not rely on one variable to achieve target
  • Easily understood
  • Reduces potential of falling in time-inconsistency trap
  • Stresses transparency and accountability
  • Improved performance
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10
Q

Explain the disadvantages of inflation targeting (4)

A
  • Delayed signalling
  • Too much rigidity
  • Potential for increased output fluctuations
  • Low economic growth during disinflation
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11
Q

What is the difference between inflation expectations and inflation forecasting (3)

A

• This is not the same as forecasting inflation:
- Forecasting is about what will (most likely) happen
- Expectations are about what firms and households think will happen, they can be wrong
- Expectations, however, can be self-fulfilling
If every firm expects 3.2% inflation and raise prices accordingly, then inflation is going to be 3.2%

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12
Q

Inflation targeting: monitoring inflation expectations

Can a CB be wrong when it forecasts its inflation?

A
  • Yes. Inflation forecasting is a very complex process and CBs are often wrong
  • Point estimates are typically wrong
  • Implies the CB cannot stabilise the economy perfectly
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13
Q

What are the lessons for monetary policy strategy from the global financial crisis (GFC) (4)

A
  1. Developments in the financial sector have a far greater impact on economic activity than was earlier realised
  2. The zero lower bound on interest rates can be a serious problem
  3. The cost of cleaning up after a financial crisis is very high
  4. Price and output stability do not ensure financial stability

What are the implications of these 4 lessons for inflation targeting?

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14
Q

Define an asset price bubble and the two types of asset-price bubbles

A

• Asset price bubble: pronounced increase in asset prices that depart from fundamental values which eventually burst

The fundamental value of an asset is the present value of the stream of income or services that asset entitles its owner to. E.g

• Types of asset-price bubbles:

  1. Credit driven bubbles eg subprime mortgages
  2. Bubbles driven solely by ‘irrational exuberance
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15
Q

What is the equation for an asset price bubble?

A

SEE NOTES

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16
Q

Name some asset price bubbles from the last 400 years`:

A
  1. real-estate in US, UK, Spain 2002-2007
  2. otc stocks in US 1995-2000
  3. The late 1920s stock price bubble
17
Q

Should central banks respond to bubbles? (essay style) use A doctrine

A
  • The ‘lean versus clean’ debate
  • Strong argument for not responding to bubbles driven by irrational exuberance
  • The ‘Greenspan doctrine’ reflects five arguments
    • Bubbles nearly impossible to identify
    • Raising interest rates may be ineffective in restraining bubbles
    • Interest rates are a blunt tool
    • A bubbles may be present in only a fraction of asset markets

• Pricking bubbles can have harmful effects on the aggregate economy

• Better to ease MP aggressively when bubble bursts (supports ‘clean’ argument)
- Monetary policy should not be used to prick bubbles

• Strong argument for responding to bubbles
- The GFC did demonstrates that credit driven bubble bursts are hard to clean up

• Important of distinguish between the two bubbles

- Instead of leaning against potential asset price bubbles (both types,) rather lean against credit booms - If asset price bubbles are rising at the same time that credit is booming, then it is likely that asset prices are deviating from fundamentals - lax credit standards
18
Q

What policies are effective in restraining credit-driven bubbles? (2)

A

• Macroprudential policy:
- Regulatory policy to affect what is happening in credit markets in the aggregate

• Monetary policy:
- Central banks and other regulators should not have a laissez-faire attitude and let credit driven bubbles proceed without any action

19
Q

Summarise Monetary policy briefly?

A
  1. Six basic monetary policy goals with price stability being the primary goal
  2. A strong nominal anchor is a key element of a successful monetary policy
  3. Advantages and Disadvantages of inflation targeting
  4. The lessons of the global financial crisis:
    - provide support for perhaps a flexible inflation targeting possibly with higher inflation target
    - suggest that monetary policy should lean against credit booms but not asset price bubbles

Money and Banking (10 decks)

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