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In what sense can greater central bank independence make the time-inconsistency problem worse?

Short Answer

Expert verified

The advantage of having so many channels through monetary policy can operate is the freedom of having multiple ways to stimulate economy whereas, the disadvantage is that these various channels indicate many ways that output and inflation might change.

Step by step solution

01

Content Introduction

The central bank choose from a variety of methods when restoring stability in inflation and output so when one method does not work, there brings various other alternative.

02

Content Explanation

There is less formal accountability for central banks to follow stable inflation policies when they are more independent. In this way, it's simpler for central banks to provide the impression of wanting to pursue low inflation policies while actually adopting more expansionary policies to reduce unemployment and boost output. Even with greater central bank independence, the problem of time inconsistency can be mitigated to some extent through greater transparency and communication, which means that the public is less likely to be misled into false expectations, and thus the central bank is less likely to pursue overly inflationary policies to boost output and lower unemployment in the short term.

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Most popular questions from this chapter

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?

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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."

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