Chapter 19 The Condict of Monetary Policy: Strategy & TacticsI. Monetary Targeting- annual growth rate of a monetary aggregate. The central Bank is reasonable for hitting targeta. Not a reliable guide for targeting moneytary growthb. Most Countries abondended philosophy c. Advantagesi. Public can know if bank is hitting target almost immediatelyii. Immediate accountability to keep inflation lowd. Disadvantagesi. If relationship between monetary aggregate and the goal viable is weak, monetary aggregate targeting will not work II. Inflation Targeting- a. Elementsi. Public announcement of mediumterm numerical objects(targets) for inflationii. An institutional commitment to price stability as the primary long term goal of monetary policy and a commitment to achieve the inflation goaliii. An information inclusinve approach in which many variables are used in making decisions about monetary policyiv. Increased transparency of the monetary policy strategy through communication with public about plans and objectives v. Increased accountability of the central banks for attaining its inflation objectivesb. Advantagesi. Stability in the relationship of money and inflation is not criticalii. Use all info to determine the best monetary policyiii. Readily understood by the public iv. Highly transparentv. Increased accountability of central banks vi. Reduce political pressure on the banks in order to keep unemployment low c. Disadvantagesi. Delayed Signaling 1. inflation has a lagii. Too Much Rigidity1. limits ability to respond to unforeseen circumstancesiii. Potential for Increased Output Fluctuations1. monetary policy that is too tight when inflation is above levels and lead to large output fluctuationsiv. Low economic Growth1. low growth if output and employmentIII. Monetary Policy with an Implicit Nominal Anchora. Monetary policy effects have long lagsb. “Just Do It Approach”i. Advantages1. same advantages of inflaton targeting 2. does not rely on stable money inflation relationshipsii. Disadvantages1. lack of transparencya. unnecessary colatility in financial markets2. hard to hold Fed accountable3. strong dependence of people running the Fed IV. Choosing the Policy Instrumenet-is a variable that responds to the central banks tools and indicates the stance of monetary policya. Reserve Aggregatesi. Reserves ii. Nonborrowed reservesiii. Monetary baseiv. Nonborrowed baseb. Interst Ratei. Short term 1. Federal Funds Ratec. Criteria for Shoosing Policy Instrumenti. Observable and Measuable1. interst rates are more observable and measurableii. Controllable1. have effective control over a variable iii. Predictable Effects on Goals1. must have a predictive effect on a goal2. most banks use short trerm interest ratesV. The Taylor Rule- federal funds rate should be set equal to the inflation rate plus an equilibrium real fed funds rate plus a weighted average of two gaps: inflation gap(current inflation minus target), and an output gap(percentage division of real GDP from an estimate of its potential full employment levela. Federal Funds Rate Target=inflation rate+eq. real federal funds ratei. Equilibrim Federal Funsd Rate=.5(inflation gap)+.5(output gap)b. Rise of inflation by 1% leads to a rise in Fedral funds rate of .5%VI. Central Banks response to Asset Price Bubblesa. Two types of asset price bubblesi. Credit Driven Bubble1. easy credit can be used to purchase particular assets which inturn can lead to higher prices.2. this increase in prices of assets can increase banks assets ewhich can enable it to lend more money3. this increase in price of assets can cause investors to have more collateral to take out bigger loans ii. Bubbles driven by irrational exuberance1. far less dangerous because it does not cause people to go bankruptb. Should central banks respond to bubblesi. No because it is almost immpossibe to identify bubbles before theyburst. If one could there would be no bubblec. Should Monetary Policy try to prick asset priced bubblesi. NoVII. Fed Policy Procedures: Historical Perspectivea. Early Earls: Discount Policy as the the Primary Tolli. Used discount rate to stop inflationb. Discovery of open Market Oerationsi. Accidentily discovered thisc. The Great Depressioni. Did not act as a lender of last resort and 1/3 of banks failed d. Reserve Requirment as a Policy Tooli. Could now alter reserve requirments without presidents approvale. War Financing and Pegging the Interest Ratei. Fed would purchase bonds to drive prices up and keep YTTM down to make fiancing the war cheap. f. Targeting Money Market Conditionsi. As National Income Rose, lead to rise in market interest rate, then the fed would purchase bonds to bid prices up and lower interest reates, monetary base would rise, money supply would