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Chapter 20: Q 6. (page 546)

Why are central banks so concerned with inflation expectations?

Short Answer

Expert verified

Central banks are so concerned with inflation expectations as they influence the consumption habits of enterprises and consumers.

Step by step solution

01

Step 1. Define inflation.

Inflation is defined as a broad, gradual increase in the prices of goods and services in an economy. When the general price level rises, each unit of currency purchases fewer products and services; hence, inflation equates to a loss of money's purchasing power.

02

Step 2. Why are central banks worried about inflation expectations?

Central banks are worried with inflation expectations because they influence the consumption habits of enterprises and consumers, which in turn affects the economy's stability.

When inflation expectations grow, the short-run aggregate supply curve shifts upward, resulting in higher short-run actual inflation in addition to any inflationary impacts that may occur.

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Most popular questions from this chapter

If credit cards were made illegal by congressional legislation, what would happen to velocity? Explain your answer.

According to the portfolio theories of money demand, what are the four factors that determine money demand? What changes in these factors can increase the demand for money?

If velocity and aggregate output remain constant at 5and \(1,000billion, respectively, what happens to the price level if the money supply declines from \)400 billion to$300 billion?

Go to the St. Louis Federal Reserve FRED database, and find data on the budget deficit (FYFSD), the amount of federal debt held by the public (FYGFDPUN), and the amount of federal debt held by the Federal Reserve (FDHBFRBN). Convert the two 鈥渄ebt held鈥� series to 鈥淎nnual鈥� using the frequency setting. Download all three series into a spreadsheet. Make sure that the rows of data align properly to the correct dates. Note that for the deficit series, a negative number indicates a deficit; multiply the series by 鈥�1 so that a deficit is indicated by a positive number. Manipulate the three series so that all data are given in terms of the same units (either millions or billions of dollars). To do this, if a series is in millions and you are converting it to billions, divide the series by 1,000. Finally, for each year, convert the two 鈥渄ebt held鈥� series into one 鈥渃hanges in debt holdings by the public and the Federal Reserve鈥� series by calculating, for each year, the difference in bond holdings from the preceding year.

a. Create a scatter plot showing the deficit on the horizontal axis and the change in bond holdings by the public on the vertical axis, using the data from 1980 through the most recent period of data available. Insert a fitted line into the scatter plot, and comment on the relationship between the deficit and the change in public bond holdings.

b. Create a scatter plot showing the deficit on the horizontal axis and the change in bond holdings by the Federal Reserve on the vertical axis, using the data from 1980 through the most recent period of data available. Insert a fitted line into the scatter plot, and comment on the relationship between the deficit and the change in Federal Reserve bond holdings.

c. Now repeat part (b), but create separate scatterplots for the period of 1980 to 2007, and 2008 to the most recent year. Comment on how, if at all, the monetizing of the debt is exhibited in the data. Do you think the relationship between the deficit and the change in bond holdings of the Federal Reserve has changed since 2008? Why or why not?

If large budget deficits cause the public to think there will be higher inflation in the future, what is likely to happen to the short-run aggregate supply curve when budget deficits rise?
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