1. Chapter 11 – Monetary Policy and Debates
Money and Banking – Michael Brandl ©2017 Cengage Learning

2. 11-1a Goals of Monetary Policy
Price level stability is one of the most important goals of monetary policy.
The goal is to keep inflation and deflation from becoming a problem.
Price level stability – How much “stability” is optimal?
Money and Banking – Michael Brandl ©2017 Cengage Learning

3. 11-2a High Employment Goal
Should high employment be one of the goals of monetary policy?
Think about all of the factors that go into determining the level of employment in an economy: the skill levels of the workforce, the derived demand of the output, the level of uncertainty of business, among others
Keep in mind there are several types of unemployment.
Frictional
Structural
Cyclical
Money and Banking – Michael Brandl ©2017 Cengage Learning

4. 11-2b Financial Market Stability: Interest Rates & Exchange Rates
Stable interest rates would make business investment decisions easier because the cost of capital for firms would fluctuate less.
Stable interest rates would increase the amount of durable goods households could purchase.
Stable exchange rates would make it easier to price imports and exports.
Should financial market stability be part of monetary policy?
Money and Banking – Michael Brandl ©2017 Cengage Learning

5. 11-3a Central Bank Independence
Central banks are generally seen as being independent of the political process: They answer only indirectly to elected officials
Another complaint about the Fed, and thus the need to limit the Fed’s independence, is that the Fed has gone soft on fighting inflation, accusing it of “debasing the currency”
Would more political control over central banks make these powerful entities more answerable to the people and push the central bankers to do a better job controlling inflation?
Money and Banking – Michael Brandl ©2017 Cengage Learning

6. 11-3b Instruments & Targets
Central banks have a major problem in the conduct of monetary policy because of lags. There are information lags
Information lag
Impact lag
There is a delay between when the Fed changes policy and when that policy affects employment, output, and prices.
The Fed has to think about how can it use its tools to affect policy instruments—those things the Fed can directly affect—and thus hit some targets with the intent of achieving its goals.
Money and Banking – Michael Brandl ©2017 Cengage Learning

7. 11-4a Taylor Rule and Inflation
The Taylor Rule assumes that the Fed has a 2% “target rate of inflation”
When real GDP equals potential GDP and inflation is at its target rate of 2 percent, the federal funds target rate should be 4%.
A real federal funds rate of 2% =
4% nominal federal funds rate - 2% inflation rate
Money and Banking – Michael Brandl ©2017 Cengage Learning

8. 11-4b Taylor Rule and Output Gap
The output gap is the percentage difference in the actual level of output and what the level of output would be if the economy were at full employment or the GDP at its potential.
The Taylor Rule suggests the Fed should lower its target for the federal funds rate.
Taylor Rule would imply that the target for the federal funds rate should be negative!
Money and Banking – Michael Brandl ©2017 Cengage Learning

9. 11-4c Mankiw Rule: An Alternative to the Taylor Rule
“Mankiw Rule” uses the consumer price index core inflation rate over the previous 12 months and the seasonally adjusted unemployment rate.
Federal funds rate = (core inflation – unemployment)
Money and Banking – Michael Brandl ©2017 Cengage Learning

10. 11-5 Monetary Policy and the Crisis
Joseph Stiglitz argues that monetary policy in the U.S. at the time of the crisis focused on 6 generally accepted ideas:
Price stability is a necessary and almost sufficient condition for economic stability
There is no such thin as an asset bubble
Even if there were a bubble, one can’t tell until after it breaks
Even if the Fed realized there was a bubble, it didn’t have the tools to deal with the problem
Even if the Fed had the tools to deal with the bubble, it should not use them
It is better to clean up after the bubble breaks than to interfere in the market beforehand
Money and Banking – Michael Brandl ©2017 Cengage Learning