Transcript Ch. 18

Chapter 18
Conduct of Monetary
Policy: Goals and
Targets
Goals of Monetary Policy
Goals
1. High Employment
2. Economic Growth
3. Price Stability
4. Interest Rate Stability
5. Financial Market Stability
6. Foreign Exchange Market Stability
Goals often in conflict
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18-2
Central Bank Strategy
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18-3
Money Supply Target
1. M d fluctuates between
M d' and M d''
2. With M-target at M*, i
fluctuates between i'
and i''
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18-4
Interest Rate Target
1. M d fluctuates
between M d' and
M d''
2. To set i-target at i*
Ms fluctuates
between M' and M''
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18-5
The incompatibility of i and M targets
• Interest-rate and monetary aggregate targets
are incompatible.
• A central bank can hit one or the other but
not both.
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18-6
Criteria for Choosing Targets
Criteria for Intermediate Targets
1.Measurability
Quick and accurate
Monetary aggregates with two-week delay, interest-rate available
immediately, and GDP less accurate and long-time delay.
Is i target better? Not necessary. We care ir, but it is hard to measure
because of expected π.
2.Controllability
Is i target better? Not necessary.
3.Predictably Effect on Goals
Interest rates aren’t clearly better than Ms on criteria 1 and 2 because hard
to measure and control real interest rates
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18-7
Criteria for Choosing Targets
Criteria for Operating Targets
Same criteria as above
Reserve aggregates and interest rates about equal on
criteria 1 and 2.
s
For 3, if intermediate target is M , then reserve
aggregate is better; if the desired intermediate
target is an interest rate, the preferred operating
target will be federal funds rate.
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18-8
Taylor Rule, NAIRU and the Phillips Curve
Taylor Rule
Fed funds rate target = inflation rate +
equilibrium real fed funds rate +
1/2 (inflation gap) +
1/2 (output gap)
Taylor has assumed that equilibrium real fed funds rates
(consistent with full employment in the long run) is 2%
and that an appropriate target for inflation would be also
2%, with equal weights of ½ on the inflation and output
gaps.
Example: π=3% , and GDP was 1% above its potential.
Then Taylor rule suggests that Fed funds rate should be
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set at 6%.
18-9
Taylor Rule, NAIRU and the Phillips Curve
Phillips Curve Theory
Change in inflation influenced by output relative to potential, and
other factors
When unemployment rate < NAIRU, inflation rises
NAIRU thought to be 6%, but inflation falls with unemployment rate
below 5%
Phillips curve theory highly controversial
• Potential GDP is a function of the natural rate of unemployment, which
is consistent with full employment
• Nonaccelerating inflation rate of unemployment (NAIRU): the rate of
unemployment at which there is no tendency for inflation to change.
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18-10
Taylor Rule and Fed Funds Rate
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18-11