The Conduct of Monetary Policy: Strategy and Tactics
The most common definition that monetary policymakers use for price stability is
Inflation results in
Economists believe that countries recently suffering hyperinflation have experienced
A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor.
A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal
A nominal anchor promotes price stability by
Monetary policy is considered time-inconsistent because
The time-inconsistency problem with monetary policy tells us that, if policymakers use discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule.
The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor long-run outcomes is referred to as the
The ________ problem of discretionary policy arises because economic behavior is influenced by what firms and people expect the monetary authorities to do in the future.
If the central bank pursues a monetary policy that is more expansionary than what firms and people expect, then the central bank must be trying to
The time-inconsistency problem in monetary policy can occur when the central bank conducts policy
Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?
Answer: With policy discretion, policymakers have an incentive to attempt to increase output by pursuing expansionary policies once expectations are set. The problem is that this policy results not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary behavior.
Even if the Fed could completely control the money supply, monetary policy would have critics because
High unemployment is undesirable because it
When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called
Unemployment resulting from a mismatch of workers' skills and job requirements is called
The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the
Supply-side economic policies seek to
The Federal Reserve System was created to
Having interest rate stability
Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries.
Which set of goals can, at times, conflict in the short run?
The primary goal of the European Central Bank is
The mandate for the monetary policy goals that has been given to the European Central Bank is an example of a ________ mandate.
The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate.
Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the ________.
The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is
Which of the following is not an element of inflation targeting?
The first country to adopt inflation targeting was
In both New Zealand and Canada, what has happened to the unemployment rate since the countries adopted inflation targeting?
Which of the following is not an advantage of inflation targeting?
Which of the following is not a disadvantage to inflation targeting?
The decision by inflation targeters to choose inflation targets ________ zero reflects the concern of monetary policymakers that particularly ________ inflation can have substantial negative effects on real economic activity.
Inflation targets can increase the central bank's flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations.
Explain what inflation targeting is. What are the advantages and disadvantages of this type of monetary policy strategy?
Answer: There are five main elements to inflation targeting: 1. a public announcement of a medium-term target for the inflation rate; 2. a commitment to price stability as the primary long-term goal of policy; 3. many variables are used in making decisions about policy moves; 4. increased transparency about policy strategy with the public; 5. the central bank has increased accountability for attaining policy goals.
The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical target for the inflation rate; 2. there is increased accountability of the central bank; 3. reduces the effects of inflationary shocks.
The disadvantages of inflation targeting include: 1. there is a delayed signal about the achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation rate (has not happened in practice); 3. if sole focus is the inflation rate, larger output fluctuations can occur (has not happened in practice).
The type of monetary policy regime that the Federal Reserve has followed From the 1980s up until the time Ben Bernanke became chair of the Federal Reserve in 2006 can best be described as
Estimates from large macroeconometric models of the U.S. economy suggests that it takes over ________ for monetary policy to affect output and over ________ for monetary policy to affect the inflation rate.
Which of the following is not a disadvantage of of the Fed's "just do it" approach to monetary policy?
Suppose it takes roughly two years for monetary policy to have a significant impact on inflation. If inflation is currently low but policymakers believe inflation will rise over the next two years with an unchanged stance of monetary policy, when should they tighten monetary policy to prevent the inflationary surge?
Under Alan Greenspan and Ben Bernanke, the Federal Reserve was successful in
pursuing a ________ policy.
After Ben Bernanke became chair of the Fed in 2006, he
The FOMC finally moved to ________ on January 25, 2012, when it issued its "Statement on Long-Run
Goals and Monetary Policy Strategy."
In the FOMC's "Statement on Long-Run Goals and Monetary Policy Strategy,"the FOMC agreed to a single numerical value of the inflation objective, 2% on the ________.
The FOMC "Statement on Long-Run Goals and Monetary Policy Strategy"made it clear that the Federal Reserve would be pursuing ________, consistent with its dual mandate.
Lessons that economists and policy makers have learned from the recent global financial crisis include
The problems of raising the level of the inflation target include
The "Greenspan doctrine"—central banks should not try to prick bubbles—was based on which of the following arguments?
When asset prices increase above their fundamental values it is called an
Suppose interest rates are kept very low for a long time such that there is a spike in the amount of lending. Everything else held constant, this could cause ________ bubble.
A credit-driven bubble arises when ________ in lending causes ________ in asset prices which can cause ________ in lending.
________ bubble is driven entirely by unrealistic optimistic expectations.
Everything else held constant, a credit-drive bubble is generally considered to have the potential to cause ________ damage to an economy compared to an irrational exuberance bubble.
A central bank has ________ chance to identify a credit-driven bubble compared to an irrational exuberance bubble.
Which of the following is NOT an argument against using monetary policy to prick asset-price bubbles?
Which of the following is NOT an operating instrument?
Which of the following is a potential operating instrument for the central bank?
Due to the lack of timely data for the price level and economic growth, the Fed's strategy
If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because
If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand are prevalent
Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate if the Fed targets
Real interest rates are difficult to measure because
Which of the following criteria need NOT be satisfied for choosing a policy instrument?
Which of the following is NOT a requirement in selecting a policy instrument?
When it comes to choosing an policy instrument, both the ________ rate and ________ aggregates are measured accurately and are available daily with almost no delay.
Answer: See figure - Chapter 16 Number 66
When nonborrowed reserves are held constant, increases in the demand for reserves result in the federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the federal funds rate declining. Since fluctuations in demand do not cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds rate is below the discount rate).
According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation ________ the Fed's inflation target or when real GDP ________ the Fed's output target.
Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be
Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be
According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should be ________ by ________ than the inflation rate increase.
If the Taylor Principle is not followed and nominal interest rates are increased by less than the increase in the inflation rate, then real interest rates will ________ and monetary policy will be too ________.
The rate of inflation tends to remain constant when
The rate of inflation increases when
Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?
Answer: The Taylor rule specifies that the target federal fund rates should be set to equal the equilibrium real federal funds rate, plus the rate of inflation (for the Fisher effect), plus one-half times the output gap, plus one-half times the inflation gap. The formula is
Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output gap) + (inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment real GDP. The inflation gap is the difference between actual inflation and the central bank's target rate of inflation. The equilibrium real federal funds rate is the real rate consistent with full employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets the federal funds rate recognizing the goals of low inflation and full employment (or equilibrium long-run economic growth).
In pursuing a strategy of monetary targeting, the central bank announces that it will achieve a certain value (the target) of the annual growth rate of a ________.
During the years 1979 to 1982, the Federal Reserve's announced policy was monetary targeting. During this time period the Federal Reserve
Compared to the United States, Japan's experience with monetary targeting during the 1978––1987 period performed
One of the factors that contributed to the success German policymakers had using a monetary targeting type policy starting in the mid-1970s and continuing through the next two decades was that
The European Central Bank (ECB) pursues a hybrid monetary policy strategy that has elements in common with the -targeting strategy previously used by the Bundesbank but also includes some elements of targeting.
Which of the following is an advantage to money targeting?
Which of the following is a disadvantage to monetary targeting?
If the relationship between the monetary aggregate and the goal variable is weak, then
The monetary policy strategy that relies on a stable money-income relationship is
In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary policy was known as the
The guiding principle for the conduct of monetary policy that held that as long as loans were being made for "productive" purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the
The real bills doctrine was the guiding principle for the conduct of monetary policy during the
The Fed accidentally discovered open market operations in the early
The Fed accidentally discovered open market operations when
The Fed's mistakes of the early 1930s were compounded by its decision to
During World War II, whenever interest rates would ________ and the price of bonds would begin to ________, the Fed would make open market purchases.
During World War II, whenever interest rates would rise and the price of bonds would begin to fall, the Fed would
During World War II, the Fed in effect relinquished its control of monetary policy through its policy of
The Fed was committed to keeping interest rates low to assist Treasury financing of budget deficits
The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to
During the 1950s, the Fed targeted
During the 1950s, Fed monetary policy targeted
Targeting interest rates can be procyclical because
High inflation can spiral out of control when
In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be
In practice, the Fed's policy of targeting ________ in the 1960s proved to be ________, destabilizing the economy.
Although the Fed professed employment of a monetary aggregate targeting strategy during the 1970s, its behavior suggests that it emphasized
Although the Fed professed employment of ________ targeting during the 1970s, its behavior suggests that it emphasized ________ targeting.
The Fed's use of the federal funds rate as an operating target in the 1970s resulted in
The Fed's use of the ________ as an operating target in the 1970s resulted in ________ monetary policy.
In the 1970s, the Fed selected an interest rate as an operating target rather than a reserve aggregate primarily because it
The Fed operating procedures employed between 1979 and 1982 resulted in ________ swings in the federal funds rate and ________ swings in the M1 growth rate.
The fluctuations in both money supply growth and the federal funds rate during 1979-1982 suggest that the Fed
Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an operating target.
The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American competitiveness, putting pressure on the Fed to pursue a more ________ monetary policy.
A borrowed reserves target is ________ because increases in income ________ interest rates and discount loans, causing the Fed to ________ the monetary base, everything else held constant.
Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the
Since the early 1990s, the Fed has conducted monetary policy by setting a target for the
The Fed can engage in preemptive strikes against a rise in inflation by ________ the federal funds interest rate; it can act preemptively against negative demand shocks by ________ the federal funds interest rate.
International policy coordination refers to