Exam 18: Alternative Perspectives on Stabilization Policy

Assume that an economy starts at a long-run equilibrium with a natural rate of unemployment equal to 6 percent and an inflation rate of 10 percent. Assume that there is a short-run tradeoff between inflation and unemployment as described by a Phillips curve. Use the Phillips curve to graphically illustrate why a central bank that desires both low inflation and low unemployment has the incentive to renege on an announced policy to reduce inflation to 3 percent, if people set wages and prices on the expectation of 3 percent inflation and the central bank has the discretion to change its monetary policy after these expectations are set.

In practice, inflation targeting is better considered as operating with constrained discretion rather than according to a policy rule because central banks with inflation targets typically:

The Phillips curve describing an economy takes the form u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, $\pi$ is the inflation rate, E $\pi$ is the expected inflation rate, and $\alpha$ and $\gamma$ are behavioral response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. In an economy in which the central bank dislikes inflation much more than unemployment:

Central-bank independence refers to:

Increasing government spending when the economy is in a recession is an example of:

The long and variable lag before a policy influences the economy makes the job of economic forecasters:

You are hired as a consultant to set up the central bank of a new country. Suggest at least two possible ways to structure the central bank to keep inflation levels low.

If past policies kept the economy insulated from shocks to aggregate demand and supply, the historical evidence would support using:

Inflation targeting is a monetary policy rule that requires the central bank to adjust _____ in order to attain the desired inflation rate.

The lags involved in implementing monetary and fiscal policy are:

When a government honors its debt obligations, this is an example of:

Arguments in favor of passive economic policy include all of the following except:

Conducting monetary policy so that the FF rate = 0.05, where the FF rate is the nominal federal funds interest rate, is an example of :

The lag between the time that the money supply is increased and the time that investment expenditures increase is an example of a:

Research indicates that greater central-bank independence is correlated with:

"Economic policies have potential to provide politicians with the justification theories to defend their own agendas." Does this statement imply that politicians always use economics to satisfy their individual agendas?

Because monetary and fiscal lags are long and variable:

If past economic fluctuations resulted from inept economic policies, then the historical evidence would support using:

Which of the following is an example of a fiscal policy that has no inside lag?

The people of Country A believe that their regulators are committed to a zero inflation policy while the people of Country B do not believe that their regulators are committed to a zero inflation policy. What difference does this make if regulators of both the countries announce a policy that will lower inflation?