Econ 2133 1st Edition Lecture 19 2nd Class of 2 the last exam is on Current Lecture Time Line 1960s Wage Price Spiral ppl believing there was an exploitable relationship between inflation and unemployment to permanently reduce unemployment rate by constantly raising inflation but we know that doesn t work and we call it a phillips curve 1970s Inflation unlike we have ever known in our young lives 1980s For better or for worse that they had to be about disinflation we had to get it out of the economy recession 81 and 82 due to interest rates coming down took rest of decade to get it back down to more normal levels We never had deflation just when the inflation rate fell so prices were increasing at a decreasing rate 1990s to 8 8 2007 Achievement and maintenance of price stability won at a great cost the recession of 81 82 to maintain low and stable inflation Monetary Policy Regime 10 1982 to 8 8 2007 8 9 2007 to Now Financial Market Rescue Stabilization Stop markets from going off the cliff then once they are rescued they need to be stabilized fed reserve bought all assets and liquefy financial markets Specifically targeted housing market Sometime soon the day when interest rates go up could be June September honestly no one has a clue new monetary policy regime and financial crisis in 2008 everything we did to get over it will be done with and in the rearview mirror Indepth Time Line 1970s to 10 1979 Interest rate targeting Monetary Policy Regime didn t do so well though Why Because it was due to it being an era of inflation can t target interest rates in an inflationary economy Fed MUST choose a Target interest rates b Target growth rate of Money Supply Ms BUT cannot do both Leads to Circle of Death stayed with failed policy for far too long 1979 P 14 and Prime 20 10 1979 Paul Volker appointed by Jimmy Carter claims to switch to a regime of monetary policy set of guiding principles that s going to target the growth rate of the money supply because we know that money stock targeting is an inflation buster and the number one thing we need to so is disinflate the economy Fisher s Equation of Exchange Ms x Velocity Price x Quantity aka Total Spent Ms x V NGDP Ms x V P x Q Ms x V P x Q Q real GDP increases by 2 5 to 3 a year secular trend Say V is constant if I want 2 5 growth at least These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Target change in M1 3 to increase Ms Ms x V P x Q Increase V by 1 Ms increases by 2 P doesn t increase and Q increases by 3 Want Ms to increase to 6 decrease Velocity by 3 in order to get the 3 growth rate in Q Worked only for a while until environment changed M1 velocity is the issue Y a bx c linear function as long as velocity to trace data and extrapolate that relationship project forward from known data Changes direction and becomes wild function in 10 1979 to 10 1982 era of money stock targeting Increase Ms by 3 because V will not change to give desired outcome on inflation and output is what they used to say How do you know 3 increase on Ms is right idk Why 3 then Is that what the financial bank should say The Velocity is a fickle beast because current regime is not sound 10 1982 Switched Monetary Policy Regime Achievement Maintenance of price stability which led to implicate inflation targeting Stable prices our 1 Goal Inflation and expended inflation as long as inflation is under 2 we are good can even stand and continue to be expansionary Inflation target 2 above contractionary fiscal policy below good because expansionary Implicit inflation targeting in US vs Explicit inflation targeting New Zealand 1989 inflation rate 3 sole criterion on which you will be judged Every January the central bank has letter to Prime Minister saying either 1 Here s your 3 inflation 2 Here s why we missed the 3 target and also here s my resignation called accountability Gives clarity of purpose is provided to central banks need 3 inflation rate makes it easier to fix it UK and Australia jump aboard even Israel Canada ECB Sweden all these explicitly followed suit US did it implicitly charter still same for the Fed since 1913 But implicitly means it s understood and that s how you behave even if it s never written down Fed switches to financial market rescue and stabilization Fed has done unprecedented things they have never done before this is where we get the camel hump and red monster Frist time ever we bailed out firms How to correct this Only respond to liquidity problems and not solvency problems