30 Questions
What is the main purpose of a nominal anchor in monetary policy?
To guide private agents' expectations about the nominal price level
Why is a nominal anchor considered crucial in successful monetary policy implementation?
It prevents time-inconsistency issues
In what scenario would a central bank NOT be utilizing a nominal anchor effectively?
When adjusting monetary policy based on long-term outcomes
What key issue arises when a central bank does not have a nominal anchor for monetary policy?
Long-term uncertainty for private agents
How does a nominal anchor help central banks avoid day-to-day adjustments in monetary policy?
By promoting time-consistent policy actions
Why should price stability be considered the primary goal of monetary policy?
To address time-inconsistency issues
What is the primary long-run goal of monetary policy in inflation targeting?
Price stability
Which approach is preferred in inflation targeting regarding the pursuit of price stability?
Hierarchical mandates
What does inflation targeting involve regarding public announcement?
Announcement of medium-term numerical objectives for inflation
What is a key reason for favoring hierarchical mandates in inflation targeting?
To prevent overly expansionary policy
What is an inclusive approach used in making decisions regarding monetary policy under inflation targeting?
Using many variables
Regarding accountability, what is required of central banks in inflation targeting?
Attaining inflation objectives
What is the purpose of implementing measures to constrain credit booms?
To promote transparency and ensure adequate capital reserves
Which of the following is NOT listed as a measure to constrain credit booms in the text?
Using monetary aggregates to guide policy decisions
How do low interest rates impact the behavior of assets managers in financial institutions?
Raise incentives for seeking higher yields and increasing risk-taking
What are the two policy instruments mentioned that the Bank of Canada uses?
Interest Rates and Reserve Aggregates
In the Taylor rule formula provided in the text, what does 'π' represent?
The target inflation
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
What is a key benefit of reducing the time-inconsistency problem in monetary policy?
Reduction in political pressure on the central bank
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
How does increased transparency in monetary policy benefit the public?
By making it easy to understand the central bank's decisions
What does consistency with democratic principles imply for inflation targeting?
The central banker has unlimited power in setting targets
Which factor contributes to improved performance in inflation-targeting countries?
Significantly reduced inflation rate and expectations
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
What is the main characteristic of asset-price bubbles driven by irrational exuberance?
Driven by overly optimistic expectations
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
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
Why does the CON case mention that stopping Bitcoin might affect other cryptocurrencies?
It's an example that not all cryptocurrencies are bubbles
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
What type of policies does the PRO case advocate for preventing credit-driven bubbles?
Macroprudential policies
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
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.
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