mon_econ_weeks10-11 - The University of Sydney Faculty of...

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The University of Sydney Faculty of Economics and Business MONETARY ECONOMICS {6 credit points} ECOS3010: semester 2, 2009 Tony Aspromourgos WEEKS X–XI : MONETARY POLICY—KEY POINTS 10.1 objectives, instruments & optimal policy 10.2 instrument choice with random disturbances – & structural ignorance 10.3 rules vs. discretion & dynamic inconsistency 10.4 the CB as an optimizing agent, reputation & credibility 10.5 ‘Taylor rules’, deflation and ‘liquidity traps’ READING: J. Forder (2001) ‘The Theory of Credibility and the Reputation-bias of Policy’, Review of Political Economy , 13 (no. 1): 5–25. G. Fontana & A. Palacio-Vera (2002) ‘Monetary Policy Rules: what are we learning?’, Journal of Post Keynesian Economics , 24 (no. 4): 547–68. 10.1 objectives, instruments & optimal policy The general point of departure for thinking about the objectives of monetary policy is the Tinbergen theorem: a necessary (but not sufficient) condition for achieving any given set of policy objectives is that there be as many instruments of policy as there are objectives. Intuitively, one may see the point of this by contemplating one policy instrument (monetary policy, setting an interest rate) simultaneously trying to pursue two objectives (say, low inflation and high real GDP growth). In the face of a supply shock – say, a sudden and dramatic rise in the price of oil – one can see how a policy dilemma might arise: the upward pressure on costs and prices (and hence potentially, upward pressure on inflation) would suggest raising interest rates; but this might compromise the second objective (high growth). On the other hand, this might not be such a dilemma if the CB only confronts demand shocks. The objectives can be rethought as a single objective – sustainable real growth, consistent with stable inflation at a desired level – and managing the real growth of demand (demand growth consistent with the supply capacity of the economy ), and managing inflation, will lead to the same or similar policy reactions. In Australia over the last decade or so, monetary policy has come to resemble this kind of operation – and the absence of any very serious supply shocks over that period has made this possible or easier. Monetary policy is the sole instrument aimed at macroeconomic objectives with respect to growth and inflation; fiscal policy plays no macroeconomic role and has become essentially the tool of the governing political party’s ideological, political and electoral objectives – and indeed, has sometimes appeared to compromise the macroeconomic objectives of monetary policy, leading to tensions (largely below the surface) between the government and the CB. A Keynesian-type policy of low interest rates has occurred, to the extent that it has occurred, by accident rather than policy intent. But it is not clear, in the kind of world in which we are now living, that there is any alternative policy instrument available which could successfully pursue
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mon_econ_weeks10-11 - The University of Sydney Faculty of...

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