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Chapter 17: Q. 15 (page 468)

Why might it be better to lean against credit-driven bubbles rather than just clean up after asset bubbles burst?

Short Answer

Expert verified

Collateral damage in an asset bubble burst is much less than the credit-pushed burst, macroeconomic coverage failure occurs whilst the credit score-pushed bubble burst in an financial system.

Step by step solution

01

Concept Introduction

An asset bubble is defined as an growth in charges of securities or different property so rapidly that it exceeds valuations of assets by way of intrinsic cost. Bubbles can harm the wider a part of the financial system, particularly if it is a key market, which include housing or the stock market.

02

Explanation

Credit-driven bubbles can be more risky to the financial system. In any other way, an growth in interest rates to reduce the bubble might also create collateral damage to the financial system. some thing must be finished to save you the prevalence of the bubble, as it's miles risky. If not anything is performed in any respect then the bubble maintains to build.
However, asset bubbles can extra effortlessly be managed after a crash; these sorts of bubbles are regular inside the monetary marketplace and monetary coverage can be particularly powerful to manipulate any recessionary situations after the burst. Collateral damage in an asset bubble burst is less than the credit-pushed burst, macroeconomic coverage failure takes place while the credit-driven bubble burst in an financial system.

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Most popular questions from this chapter

. The Federal Open Market Committee (FOMC) meets about every six weeks to assess the state of the economy and to decide what actions the central bank should take. The minutes of this meeting are released three weeks after the meeting; however, a brief press release is made available immediately after the meeting. Find the schedule of minutes and press releases under the 鈥淢eeting calendars and information鈥� tab at http://www.federalreserve.gov/fomc/.

a. When was the last scheduled meeting of the FOMC? When is the next meeting?

b. Review the press release from the last meeting. What did the committee decide to do about short-term interest rates?

c. Review the most recently published meeting minutes. What areas of the economy seemed to be of most concern to the committee members?

Why is a public announcement of numerical inflation rate objectives important to the success of an inflation-targeting central bank?

What are the benefits of using a nominal anchor for the conduct of monetary policy?

. Since monetary policy changes made through the fed funds rate occur with a lag, policymakers are usually more concerned with adjusting policy according to changes in the forecasted or expected inflation rate, rather than the current inflation rate. In light of this, suppose that monetary policymakers employ the Taylor rule to set the fed funds rate, where the inflation gap is defined as the difference between expected inflation and the target inflation rate. Assume that the weights on both the inflation and output gaps are 陆, the equilibrium real fed funds rate is 4%, the inflation rate target is 3%, and the output gap is 2%. a. If the expected inflation rate is 7%, then at what target should the fed funds rate be set according to the Taylor rule?

b. Suppose half of Fed economists forecast inflation to be 6%, and half of Fed economists forecast inflation to be 8%. If the Fed uses the average of these two forecasts as its measure of expected inflation, then at what target should the fed funds rate be set according to the Taylor rule?

c. Now suppose half of Fed economists forecast inflation to be 0%, and half forecast inflation to be 14%. If the Fed uses the average of these two forecasts as its measure of expected inflation, then at what target should the fed funds rate be set according to the Taylor rule?

d. Given your answers to parts (a)鈥�(c) above, do you think it is a good idea for monetary policymakers to use a strict interpretation of the Taylor rule as a basis for setting policy? Why or why not?

What procedures can the Fed use to control the federal funds rate? Why does control of this interest rate imply that the Fed will lose control of nonborrowed reserves?
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