Week8.ppt - Monetary Policy Goals and Targets 3 Cine of the...

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Unformatted text preview: Monetary Policy Goals and Targets 3* Cine of the key goals of central banks is price stability 3* Central banks aim to keep inflation iTaS close as possible to a target inflation leyel JTT. That is, central banks aim to minimise the inflation gap {IT-Hr} Central banks often haye a clual mandate, meaning that they also care about stablilising economic actiyity Central banks also aim to keep aggregate output Y close to the potential output “1””. EI::|ui'-.ralentlyr central banks aim to minimise the output gap (”f-W} Re5ponse of Monetary Policy to Shocks 39-“ If there is a dual mandate, monetary policy should try to minimize both the inflation gap and the output gap. P Given these policy objectiyes, we consider a central bank's response to three different kinds ofshocks: y - Aggregate demand shock — Temporary supply shock — Permanent supply shock 3+ We will see that, in the case of both aggregate demand shock and permanent supply shoclu:r monetary policy makers can indeed simultaneously pursue price stability and output stability. 3+ Howeyer, following a temporary supply shock, policy makers face a difficult choice — they can achieve either price stability or output stability, but not both. RESPDHSE to a Negative AD Shock (1') Na Puffs: Respnnse Infiafiun Plate 11. STE-[:- E'. HEIEFE-FJEI'FI'L] I::IJ'.[_:L.'. I EIJ'I-j :I'I1|.E1T_:::|": I_|"[.| _ LHAS A51 Ema-p:- ‘. T"-e.3-;;1-;in:agate I: r".'4.5.- E-I'l' f‘. :5. Aggragata 0mm, 1* Re5ponse to a Negative AD Shock (ii) Autonomous Easing of Monetorz PfliiCE Inflation LHAS " 'ii'l [.1 L'IIT r'r':r.':I"|et;'1r'-:,- ”it! demand .:_|__Jr-,I.-,_:. , -..-..-r :c.II'I'I',-' returr'ls. 1c- I'E'i'l'S-idr'uri Eli—1U llbriurn. -.~.-:1r-. ir':1|:-1t:cl'1 s1.:'anili.-~-:'ni .11 7" Step :33. decrE-:?I.slrI-n Lilliput fin-1'] ii'lilE'iii-Ui'i. EIFrb 1' THE aii'é'ii'e'i'ifiifi' {JEr'r‘uan-fl '-'"-|"-'E! E-i'lii'ts Iefiwsr-n _ Aggregate Output. 1" — No trade off between P stabilityr and ‘1’ stabiiity — The Divine Coincidence {Bionchorti}: a lack of conflict between the dual objectives Re5pense to a Permanent Negative Supply Shock (I) No Policy Response EitEIC: 1-3. and the. Ehlflr'E-I'IJP'I aggregate Supply .:-.Jr-.-e Inflation LEASE LRAS1 :-'1"r'li‘t:-"1 '.J[II'.'.'.-lr-:§ I.JI':E:| . . . Flats, 1r iii-1H1 3.':'i. ”'11:.- -:-'.--'.';::Ir"-r.:u'1'l'-' r-..-.'tI..-‘I'I';i t-:::I II::II1I;_1-r-.Jr'l I'E-IIJin:ItJ-F-UIT'. with crutpu‘. 1.:IIIIr'.I;,] {In-j Inf|.:LTn::r'. r' tar-g] AS AD 1 STEP] 1. Pi DEE-'I'r‘IJE'IE'r‘IT. ::I_-:-I;_1;"I'.I'»..'H :-:.=.I[.1[':Ii'g_.-' ':'1||II'.1!..I|-'-. 1-:u‘1lf15: H:r._'.- II:_'.Ir1I;_]-r'._1r‘. .'_1I.'_;_ :;,_;_ 2:..- YF‘ ' supply- |jl_]"".'{! ‘-.:-" --..-:_ Aggregate Gum, Y Reoponso to a Permanent Negative Supply Shock {H} Autonomous Ti htonio o Monoto Pofl To Stobflizo o: infiotim LEASE LEAH: hit-51::- ':. fl. |:I-'.-:-rrT1 :'1='Ef1t n E'-_'..] :‘i'.|".E' Stump-3.: Shoo-3H: 'E. 3" ‘t-a '.i'II:- |-:::n-;|-r-_r. Flats, 1r ra-rg-qrognfr: :_-.-|.|F:|_:_.|i':r' -:.-.r"--r.- i-.'.-‘.1'-.'.-r:r-:1. «r ------------------ O 1 > ‘ Slop: 15'. .r'"I.-.J‘.I:-r'I:-n1::::u:'. n':u.':.r'u:':t.'l.r-;.- F:.u::u§|-::-';.- tI-;_.1"'-1u:':l'nr'.;_; VF Aoomoate Duinut. Y ReSponse to a Temporary Negative Supply Shock (H) Pniicz Stebiiizes n in SR Inflatiun LHAS, Hate. 1': :_1-::'--:_:i:r|r:': I": -.'_'|:_J1:_'|._J1 t_:-I_I‘ i.:_._.:-.____[. :53 '|||:=.-'.Ir_'.-|| -'.1t T." Aggregate Dutput, 'f' The divine cnincidence dnes NET hnid. : (Le. Pniicymnkersfnce cr Sheri—run trade nfi‘ benneen stabiiizing inflatinn and ecnnnmic activity ReSponse to a Temporary Negative Supply Shock (iii) ifiniicur Stabiiizes Y in SR Infia‘tim Step. 4. Output hue: crammed LE‘HS Rate 11. Ht FJUEIE-r'ltua3:. t:II..-1:r'1-‘|L=L1--:;:-r1 if; ‘I I'ngi'mr :‘r'uan the: Large-1 Ie-.-e|. ._ r'u.+u__1:11:'-.-H :-1 : 1' - :-".i".ft.l':. 1"1r:'.- ."lfil: 'I'T """"""""" '.-'.I..Ir_:I[.'I|';.-' r.:r.Jr'-.-'e I.J[':r-.'.-:Lr[1 . . . Step; leer-rich: tag: .71 reg-:1 In :."|.'|.:IT.-:::n.-_1r--::: :1.‘.:1||Ir:I:JLerI_:1. The divine cnincicience tines NUT nnin'. -{i.e. Pniicymnkersfnce n short—run trade a}? beneveen smiliiieing infleiinn and ecnnnmic activity) Hew Active Sheuld Pelicymakers Be ? Nanactivist Palicy Suppase palicymakers face high unemplayment and law aggregate autput Hanactivists believe that wages and prices are very flexible scan the self- carrecting mechanism is rapid Hnnactivists argue that the shart—run aggregate supply curve will shift dawnwards rapidlyI returning the ecenemy ta full empleyment relatively quickly Accarding ta nanactivists, manetary palicy actian is generally unnecessary ta eliminate high unempleyment Activist Palicy Activists are sametimes called Keynesians- They believe that wages and prices are relatively inflexible {sticky}, therefcire the ecdncimy’s self— carrecting mechanism is quite slaw. Activists argue that it takes a very lang time ta reach the "lung run" in which the ecanamy is returned tc: patential eutput and full empleyment is restered. Keynes said:"ln the lung runI we are all dead". Activists therefere see the need far palicymalcers ta pursue active palicy ta eliminate high unempleyment and ta help get the ecanamy flLl'iZ ch recessian guiclcly. Legs and Policy Implementation "‘3- Several types of lags [delays] prevent policymakers from shifting the AD curve instantaneously — Data lag - Recognition lag — Legislative lag — Implementation lag 0' — Effectiveness lag iv“- The existence of these lags weakens the case for activism ii- If the policy lags are long, then by the time policymakers are able to shift the AD curve to the right, the self—correcting mechanism may have already started working to return the economy towards full employment state 3-“- Therefore, activist policy may lead to unintended rise in inflation due to esiste nce of policy lags. Inflation is a Monetary Phenomenon Te Milton Friedman : "Inflation is always and everywhere a monetary phenomenon." fr This statement is supported by our aggregate demand and aggregate supply framework. as it shows that monetary policymakers can target any inflation rate in the long run by choosing to shift the aggregate demand curve using attiye monetary policy. iv The aggregate supply curve will shift dyer time. and therefore output in the long run will always return to its potential but inflation will reach the new target leyel. Inflatiprl Flatt}. 1r iii-top 2'. and I-"-‘.!.:It I::-n rI-ses '.L': Ell-:5! FIE-w Pugh-Fir lingual i. HA5 A Rise inthe '_ 2 Inflation Target p .3. Aggregate Output, ‘r' ...
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