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Chapter 17: Q.1 (page 468)

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

Short Answer

Expert verified

Nominal anchor helps in keeping inflation expectations low and stable

Step by step solution

01

Concept Introduction  

Monetary policies are macroeconomic policies developed and implemented by the country's central bank. It demonstrates how the Central Bank manages to keep the economy's liquidity stable. The primary goal of any monetary policy is to control inflation and employment.

02

Explanation

A nominal variable such as the inflation rate that limits the price level in order to maintain price stability is referred to as a nominal anchor. It is a straightforward mechanism for determining the overall price level in the economy.

The nominal anchor helps to keep the nominal variable within a narrow range. This helps in keeping inflation expectations low and stable. A nominal anchor based on quantity only targets the money, whereas a nominal anchor based on price targets an exchange rate or an interest rate.

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Most popular questions from this chapter

. 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?

Why would it be problematic for a central bank to have a primary goal of maximizing economic growth?

鈥淎 central bank with a dual mandate will achieve lower unemployment in the long run than a central bank with a hierarchical mandate in which price stability takes precedence.鈥� Is this statement true, false, or uncertain? Explain

What does the Taylor rule imply that policymakers should do to the fed funds rate under the following scenarios?

a. Unemployment rises due to a recession.

b. An oil price shock causes the inflation rate to rise by 1%and output to fall by 1%.

c. The economy experiences prolonged increases in productivity growth while actual output growth is unchanged.

d. Potential output declines while actual output remains unchanged.

e. The Fed revises its (implicit) inflation target downward.

f. The equilibrium real fed funds rate decreases

What are the main criteria for choosing a policy instrument? Why? Explain.
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