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Chapter 25: Q. 13 (page 676)

In Japan, the government and central bank have enacted policies recently to raise inflation permanently from persistently low levels, however inflation continues to remain near zero. How, if at all, might credibility of the central bank explain the low inflation persistence?

Short Answer

Expert verified

When markets believe in a central bank's ability to maintain price stability, the central bank has to do less to maintain it.

Step by step solution

01

Content Introduction

Cost push and demand pull are the two fundamental causes of inflation. The former refers to an increase in production costs, which results in a price increase, whereas the latter refers to an increase in aggregate demand as a result of changes in consumption, investment, and government spending. According to experts, Japan's ageing and dwindling population contributes to the persistent shortfall in consumer demand by urging people to be cautious resulting in inflation.

02

Content Explanation

When markets believe in a central bank's ability to maintain price stability, the central bank has to do less to maintain it. In the absence of credibility, more forceful action is required to attain the same goal. When there is a lot of ambiguity, credibility becomes even more vital.

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Most popular questions from this chapter

Go to the St. Louis Federal Reserve FRED database, and find data on the personal consumption expenditure price index (PCECTPI). Convert the units setting to "Percent Change from Year Ago, " and download the data. Beginning in January 2012, the Fed formally announced a 2% inflation goal over the "longer-term."

a. Calculate the average inflation rate over the last four and the last eight quarters of data available. How does it compare to the2% inflation goal?

b. What, if anything, does your answer to part (a) imply about Federal Reserve credibility?

Robert Lucas won the Nobel Prize in economics. Go to http:/nobelprize.org/nobel_prizes/economics/ and locate the press release on Robert Lucas. What was his Nobel Prize awarded for? When was it awarded?

In some countries, the president chooses the head of the central bank. The same president can fire the head of the central bank and replace him or her with another director at any time. Explain the implications of such a situation for the conduct of monetary policy. Do you think the central bank will follow a monetary policy rule, or will it engage in discretionary policy?

Go to the St. Louis Federal Reserve FRED database, and find data on the core PCE price index (PCEPILFE) and the spot price of a barrel of oil (WTISPLC). For both variables, convert the units setting to "Percent Change from Year Ago, " and download the data from 1960 to the most recent available data.

a. Identify periods in which oil price inflation is 80%or higher.

b. In the periods identified in part (a), how many months was oil price inflation 80% or higher? What was the average core inflation rate during each of those episodes?

c. Based on your answers to parts (a) and (b) above, what can you conclude about the credibility of more recent monetary policy compared to its credibility in the earlier periods?

Various survey-based measures of inflation expectations are available reflecting consumer, market, and economists" outlooks. For instance, the Survey of Professional Forecasters (SPF) is available from the Philadelphia Federal Reserve at https//www.philadelphiafed.org/research-and-data/ real-time-center/survey-of-professional-forecasters/, while the well-known University of Michigan consumer inflation expectations survey is available at https://fred st1ouisfed org/series/MICH. Compare the most recent readings of inflation expectations of the SPF and Michigan survey to actual CPI inflation. In general, which one seems to be more accurate?
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