Monetary Policy: Strategy and Tactics Chapter 17

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the main purpose of a nominal anchor in monetary policy?

To guide private agents' expectations about the nominal price level (correct)

To control the nominal price level

To influence long-term interest rates

To set explicit targets for real GDP growth

Why is a nominal anchor considered crucial in successful monetary policy implementation?

It prevents time-inconsistency issues (correct)

It increases inflation rates

It eliminates the need for hierarchical mandates

It ensures flexibility in monetary policy decisions

In what scenario would a central bank NOT be utilizing a nominal anchor effectively?

When adjusting monetary policy based on long-term outcomes (correct)

When achieving price stability is not a primary goal

When implementing a strategy to control real GDP growth

When failing to manage private agents' expectations

What key issue arises when a central bank does not have a nominal anchor for monetary policy?

Long-term uncertainty for private agents Signup and view all the answers

How does a nominal anchor help central banks avoid day-to-day adjustments in monetary policy?

By promoting time-consistent policy actions Signup and view all the answers

Why should price stability be considered the primary goal of monetary policy?

To address time-inconsistency issues Signup and view all the answers

What is the primary long-run goal of monetary policy in inflation targeting?

Price stability Signup and view all the answers

Which approach is preferred in inflation targeting regarding the pursuit of price stability?

Hierarchical mandates Signup and view all the answers

What does inflation targeting involve regarding public announcement?

Announcement of medium-term numerical objectives for inflation Signup and view all the answers

What is a key reason for favoring hierarchical mandates in inflation targeting?

To prevent overly expansionary policy Signup and view all the answers

What is an inclusive approach used in making decisions regarding monetary policy under inflation targeting?

Using many variables Signup and view all the answers

Regarding accountability, what is required of central banks in inflation targeting?

Attaining inflation objectives Signup and view all the answers

What is the purpose of implementing measures to constrain credit booms?

To promote transparency and ensure adequate capital reserves Signup and view all the answers

Which of the following is NOT listed as a measure to constrain credit booms in the text?

Using monetary aggregates to guide policy decisions Signup and view all the answers

How do low interest rates impact the behavior of assets managers in financial institutions?

Raise incentives for seeking higher yields and increasing risk-taking Signup and view all the answers

What are the two policy instruments mentioned that the Bank of Canada uses?

Interest Rates and Reserve Aggregates Signup and view all the answers

In the Taylor rule formula provided in the text, what does 'π' represent?

The target inflation Signup and view all the answers

Why does the target overnight interest rate need to increase by a higher increment when inflation rises according to the Taylor rule?

To align with equilibrium real overnight rates Signup and view all the answers

What is a key benefit of reducing the time-inconsistency problem in monetary policy?

Reduction in political pressure on the central bank Signup and view all the answers

Why does inflation targeting help central bankers avoid the time inconsistency trap?

By making it clear how far the central bank is from achieving its target Signup and view all the answers

How does increased transparency in monetary policy benefit the public?

By making it easy to understand the central bank's decisions Signup and view all the answers

What does consistency with democratic principles imply for inflation targeting?

The central banker has unlimited power in setting targets Signup and view all the answers

Which factor contributes to improved performance in inflation-targeting countries?

Significantly reduced inflation rate and expectations Signup and view all the answers

How does the reduction of time-inconsistency problem relate to political pressure on the central bank?

It reduces the likelihood of political pressure on the central bank Signup and view all the answers

What is the main characteristic of asset-price bubbles driven by irrational exuberance?

Driven by overly optimistic expectations Signup and view all the answers

Why is it challenging to identify asset-price bubbles according to the CON case?

If banks can see the bubble, the market can see it too Signup and view all the answers

How does raising interest rates relate to the continuation of bubbles according to the CON case?

It might make the bursting of the bubble more severe Signup and view all the answers

Why does the CON case mention that stopping Bitcoin might affect other cryptocurrencies?

It's an example that not all cryptocurrencies are bubbles Signup and view all the answers

What is suggested as a better approach instead of taking monetary policy action according to the CON case?

Quickly addressing the bubble to minimize harm Signup and view all the answers

What type of policies does the PRO case advocate for preventing credit-driven bubbles?

Macroprudential policies Signup and view all the answers

Study Notes

The Conduct of Monetary Policy: Strategy and Tactics

A nominal anchor is a single variable or device used by the central bank to pin down expectations of private agents about the nominal price level or its path.
A nominal anchor helps to prevent the time-inconsistency problem, where the central bank's actions may not lead to the best outcome in the long run.

Should Price Stability be the Primary Goal of Monetary Policy?

Hierarchical mandates prioritize the goal of price stability and then pursue other goals as long as price stability is achieved.
Advantages of hierarchical mandates:
- Reduction of time-inconsistency problem
- Increased transparency
- Increased accountability
- Consistency with democratic principles
Dual mandates, on the other hand, seek to achieve two co-equal objectives, such as price stability and maximum employment/output stability.

Inflation Targeting

Inflation targeting involves:
- Public announcement of medium-term numerical objectives for inflation
- Institutional commitment to price stability as the primary long-run goal
- Inclusive approach to decision-making using many variables
- Increased transparency with society about strategies, plans, and objectives
- Accountability for attaining inflation objectives
Advantages of inflation targeting:
- Constrains credit booms
- Promotes accountability and transparency
- Has been shown to reduce inflation and inflationary expectations in countries that have implemented it

Choosing the Policy Instrument

A policy instrument is the variable that responds to the central bank's tools and indicates the stance of monetary policy.
The Bank of Canada uses two policy instruments: Reserve Aggregates and Interest Rates.
The Taylor Rule can be used to choose the target overnight interest rate based on inflation and output gap.

Asset-Price Bubbles

There are two types of asset-price bubbles: bubbles driven by irrational exuberance and credit-driven bubbles.
Arguments against stopping bubbles:
- They are nearly impossible to identify
- Raising interest rates may not stop bubbles and may make the bursting more severe
- Different asset prices co-exist in the market
- Monetary policy action to prick bubbles can have harmful impact on the economy
Arguments for stopping bubbles:
- Macroprudential policies can prevent credit-driven bubbles
- It's better to clean up bubbles quickly to minimize harm

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

Test your knowledge on the conduct of monetary policy with a focus on strategy and tactics. Learn about the importance of price stability goal, nominal anchors, and nominal variables. Studocu is not sponsored or endorsed by any college or university.