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ECON202answerkey5

ECON202answerkey5 - ECON 202 SPRING 2009 Malhar Nabar...

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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 &reputation¡refers to the sense ¢nancial markets and in£uential economic agents (such as unions and price-setting ¢rms) have about the central bank¤s preferences regarding in£ation and unemployment outcomes. This perception is derived from the central bank¤s 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 in£ation, ¢nancial markets will treat policy announcements as credible. If the central bank announces, for example, that an expansionary monetary policy is justi¢ed 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 isn¤t simply manipulating the Phillips Curve to achieve a more favorable outcome on unemployment. In this case, rather than revising upwards their in£ation expectations, the public may continue to maintain their pre- existing in£ation expectations since they believe that the central bank¤s intervention will o/-set the anticipated adverse demand shock. 2. Some economists advocate that central banks should adopt explicit in¡ation targets. What are some of the bene¢ts and costs associated with this policy stance?...
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ECON202answerkey5 - ECON 202 SPRING 2009 Malhar Nabar...

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