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Unformatted text preview: ECON 202, SPRING 2009 Malhar Nabar Answer Key #5 Posted: May 5 Note : There are four questions in total. You may consult with other students, but please turn in your own individual answer sheet with the names of all group members listed on the front page. Policy Stabilization 1. In the context of the central bank&s conduct of monetary policy, explain the terms - "reputa- tion" and "credibility". In the context of central banking, the term &reputationrefers to the sense nancial markets and inuential economic agents (such as unions and price-setting rms) have about the central banks preferences regarding ination and unemployment outcomes. This perception is derived from the central banks track record on policy decisions. The term &credibility refers to the trust nancial markets, unions and rms (i.e. the private economy) have in the policy announcements made by the central bank. If the central bank has a reputation for making prudent decisions that stabilize the economy close to the natural rate of unemployment with a moderate rate of ination, nancial markets will treat policy announcements as credible. If the central bank announces, for example, that an expansionary monetary policy is justied due to indicators that suggest a weakening of consumer demand , the private economy will treat this announcement as credible and will believe that the central bank isnt simply manipulating the Phillips Curve to achieve a more favorable outcome on unemployment. In this case, rather than revising upwards their ination expectations, the public may continue to maintain their pre- existing ination expectations since they believe that the central banks intervention will o/-set the anticipated adverse demand shock. 2. Some economists advocate that central banks should adopt explicit ination targets. What are some of the benets and costs associated with this policy stance?...
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This note was uploaded on 06/15/2010 for the course ECON 202 taught by Professor Nabar during the Spring '08 term at Wellesley College.
- Spring '08