( ) money supply velocity price real output MV PY × = × =
206-282 Fisher Effect Fisher Effect: Real rate of interest in an economy is stable over time so that changes in nominal interest rates are the result of changes in expected inflation. Directly related to money neutrality Improvement of Fisher Effect Risk premium (RP) is encompassed in the equation to illustrate the compensation for investors’ uncertainty about future values of some economic variables, such as inflation and real growth. [ ] Nom Real R R + E I +RP = [ ] Nom Real R R E I = +
207-282 Role and Objectives of Central Bank Roles of Central Bank: Monopoly supplier of the currency Banker to the government and bankers’ bank Lender of last resort Regulator and supervisor of the payments system Conductor of monetary policy Supervisor of the banking system Objectives of Central Bank: Maintain price stability through target inflation Maintain exchange rate stability through foreign reserves Prompt economic growth Achieve full employment Moderate long-term interest rates
208-282 Qualities of Effective Central Banks Independence The operation of central bank must, to a certain degree, be segregated from the involvement of the government. Evaluation of independence Operational independence : it was free to set interest rates in the way that it thought would best meet the inflation target. Target independenc e: it means that central banks not only decide the level of interest rates, but they also determine the definition of inflation that they target, the rate of inflation that they target, and the horizon over which the target is to be achieved.
209-282 Qualities of Effective Central Banks Credibility The public confidence in the central banks. If highly levered government set the target inflation rate, since the government had an incentive to increase inflation to reduce real value of debt, the credibility of the policy as well as the confidence in currency would be endangered. The public confidence could become self-fulfilling, prompting inflation to reach its target. Transparent Transparency in its decision-making process . Transparency means that central banks issue Inflation Reports to express their views on the economy.
210-282 Tools of the Central Bank Policy Rate The most obvious expression of a central bank’s intentions and views comes via the interest rate it sets. The name of the official interest rate (or official policy rate or just policy rate) varies from central bank to central bank, but its purpose is to influence short- and long-term interest rates and ultimately real economic activity.
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- Supply And Demand