monetary policy - building a short run model

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  • Created by: charlie
  • Created on: 06-05-16 12:02
supply > demand
inflation falls below target
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supply < demand
inflation rises above target
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Central bank 4 monetary actions
size of monetary injections / reserve requirements / discount rate (FED funds rate or base rate) / scale of intervention in bond/ foreign markets
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Central bank 2 ways of implementing MP
ST IR / monetary base (amount of money in circulation)
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Central bank aim
achieve low inflation and output close to potential
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MP history 1950-2000
fixed ex rate (buy/sell foreign reserves) / floating ex rate (oil shock instability) / monetary targets (control growth=infl) / ex rate target (relationship goes so pack $ to Ger due to low infl) / infl targeting (with gov to independent)
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Open-market operations
buying and selling gov securities (sell=reduced money supply=price of money inc=IR inc=less demand=less infl)
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Inflation targeting
Central bank uses nominal IR directly to affect infl / no upper limit / lower limit 0.5% (QE used to lower even more)
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Inflation time inconsistencies (before CB independent)
UNSTABLE / gov says will set π=0 so firms and consumers expected π=0 / wage contracts set / gov inc infl 1% / brings unemployment down 1% / gets votes
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Inflation targeting importance
expectations strongly influence economic activity / can create WAGE-PRICE spirals if not (infl outlook enables wages inc=disposable $ inc=demand inc=price inc)
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IS curve
summarises demand side / shows combination of IR + output at which agg. spending=output / locus of points where goods mart eqm (NOT RELATIONSHIP)
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IS curve history (pre/during/post depression)
believed capital and labour determined growth / agg output fell but capital and labour didn't / agg demand changes determined ST changes in agg output
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IS curve components of AD: consumption equation and symbols
.
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IS curve components of AD: Investment equation and symbols
.
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IS curve components of AD: Gov + net exports equations and symbols
.
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Goods market equilibrium: IS curve equations
.
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IS curve and output gap
CB focuses on output gap over GDP / changes in real IR affect consume, invest, gov, net exports relative to GDP
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IS curve output gap: consumption equation and symbols
.
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IS curve output gap: investment equation and symbols
.
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IS curve output gap: gov + net exports equation and symbols
.
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IS curve output gap equations
.
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IS curve output gap: long run
.
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MP: ST vs LT IR trend
ST IR has power to affect LT IR (rise+fall together)
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MP rule
inf/GDP too high, change IR by x%
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Taylor rule
since CB affects spending through IR, should directly chose IR rather than growth rate of money
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Taylor rule: equation
.
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MP equation: Fisher equation
.
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MP equation: sticky inflation assumption
changes in nominal IR=changes in real IR (no offset by infl changes) / ST infl rate doesn't directly respond to MP / CB therefore have ability to set real IR in ST
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MP equation: equations
.
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Volcker disinflation
inc IR=reduces infl (disinflation) as -ve output=recession=changed expectations=reduce IR=out of recession (lower infl) as output =0
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MP to fight crisis: problem
transition back to eqm didn't occur / CB only able to target FED funds IR + not market / usually relies in LT IR decline when repo rates (lending money to commercial banks) declines
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MP to fight crisis: default risk premium definition
difference between bond IR + US treasury bond IR (risk free) with same maturity
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MP to fight crisis: causes (default risk premium prices)
default risk premium soared/ investors feared firms would have difficulty repaying loans or making coupon and principle payments on bonds
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MP to fight crisis: causes (Real IR equation)
.
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MP to fight crisis: causes (Real IR)
FED tried to cut IR=0 / RP too high so counteracted
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MP to fight crisis: effects
IR increased due to risk premium / output stayed -ve
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MP equation: symbols
.
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Other cards in this set

Card 2

Front

supply < demand

Back

inflation rises above target

Card 3

Front

Central bank 4 monetary actions

Back

Preview of the front of card 3

Card 4

Front

Central bank 2 ways of implementing MP

Back

Preview of the front of card 4

Card 5

Front

Central bank aim

Back

Preview of the front of card 5
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