week 9

Question 1

simple definition for independency for central bank?

Answer 1

“A central bank is independent if it can make policy, such as setting interest rates or printing money, without interference from elected officials or the private sector

Question 2

what are some of the indices of central bank independence?

Answer 2

six dimensions of Romelli:
1.Governor and central bank board
2. Monetary policy
3. Objectives
4. Limitations on lending to the government
5. Financial independence
6. Reporting and disclosure

Question 3

summary what makes a central bank independent?

Answer 3

• if it has control of monetary policy objectives and instruments
• its key personnel appointments cannot be influenced by government
• it cannot eb required to lend to government

de jure and de facto - на практика и наистина

Question 4

under which expectation is inflation bias a key result?

Answer 4

• under rational expectations; time consistent equilibrium

Question 5

when is inflation bias reduced to zero?

Answer 5

when b = 0; a = infinity, or U* = Un, pt - p* = 0 inflation bias = 0

Question 6

how to central banks solve the time incosistancy problem?

Answer 6

-delegating monetary policy to an independent bank and thus reduce the inflationary bias:

1. if central bank and government preferences differ (focus is on increased 𝑎: central bank
   conservatism – which might require, or be helped by, independence)
2. if central bank and government aims differ (focus is on 𝑈∗ and how close it is to 𝑈𝑁; can – and
   should – central bank independence enable 𝑈∗ = 𝑈 𝑁?).
3. if central bank and government differ in their ability to commit to a rule
4. if central bank independence enables contracts incentivising target achievement
5. if central bank independence and greater credibility affects wage setting and Phillips curve slope (focus is on 𝑏: whether central bank independence can cause labour market “institutional” changes that make unemployment less sensitive to inflation fluctuations).
6. if central bank independence can increase expectations anchoring (focus is on how close the
   economy is to 𝜋𝑡𝑒 = 𝜋∗).

Question 7

what is the approach of conservative banks towards inflation bias?

Answer 7

• if the central bank is relatively conservative that means that they are more likely to focus on being cautious in making decisions that might allowe deviation of inflation from target
• they are more inflation averse than government => greater loss from inflation than the gov

Question 8

partially consertvative bank?

Answer 8

• ## results in lower inflationary bias

Question 9

what are the isocurves of partially conservative bank?

Answer 9

= flatter ellipse

Question 10

fully conservative bank?

Answer 10

• no weight on unemployment devations:

Question 11

what are the isocurves of the conservative central bank?

Answer 11

• horizontal line
• CB does not care about the unemployment rate so the relative cost of any deviation is infinite
• inflation bias under fully conservative CB is zero

Question 12

why are fully conservative banks problematic?

Answer 12

• delegation to a fully conservatice central bank would be problematic because they would tolerate any unemployment rate
• if the economy were hit by a large adverse shock, they would accept a large rise in unemployemtn to keep inflation on target
• trade off between credibility and felxibility since they are unwilling to respind to adverse shocks, despite their promise being credible
• even partially conservative CB would be suboptimal from gov => society’s POV

Question 13

• what does intervention + delegation mean?

Answer 13

• partial independence
• Government delegates monetary policy to an independent conservative central bank, but limits the CB’s independence
• Faced with a large shock, the government would
  override the central bank, temporarily taking back control of policy
• policy rule contingent on the state of the world => the policymaker should not always aim to achieve the inflation target, but instead should
  allow inflation to vary around the target to keep unemployment from moving far from
  the desired level.
  -But abiding by only an inflation target for monetary policy, when society also dislikes
  unemployment deviations, is suboptimal in that unemployment variability is too high.

Question 14

equilirium of the central bank?

Answer 14

• • In equilibrium, faced with the threat of being overruled by the government, the central bank is never overridden
• The central bank adjusts policy so that the government is just indifferent between intervention and non-intervention

Question 15

what are the overall results of the delegation + intervention?

Answer 15

Overall result: Unemployment variability is lower than if the conservative central bank were left to their own devices, but is still higher than the government and society would wish. Inflation bias is reduced, though average inflation over time is
higher than under conservative central bank independence without the threat of intervention.

Question 16

Might the socially optimal unemployment level ∗ be lower than its natural level U𝑁?

Answer 16

• This might arise because the economy is subject to imperfections such as
• Labour market distortions (e.g. because of taxes).
• Monopolistic competition – equilibrium output too low.

Question 17

U* < Un might be politically motivated?

Answer 17

Politicians might be motivated to aim for U∗ <U𝑁 for non-economic reasons (e.g. maximise own/party welfare, not society’s): Election coming
up, or political pressure in general.
* If the policymaker facing temptation is the government – for example, because they believe lower unemployment is needed for electoral success – then shifting policy decisions to an independent body could help.

Question 18

what is the critique from the BoE on time-incostitancy idea?

Answer 18

Put simply, the central bank uses monetary expansions to create jobs which do not exist in
the long run. In contrast, I shall assume that the central bank does not use monetary policy as a substitute for microeconomic structural reforms. Because it is not trying systematically to push unemployment below the natural rate, there is no ‘time inconsistency’ in monetary policy.”