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Chapter 15: Problem 14

How does inflation targeting work?

Short Answer

Expert verified
Inflation targeting is an economic policy where a central bank sets and strives to achieve a specific inflation level or range. They monitor inflation through economic data, like price indices, and adjust their monetary policy accordingly to maintain the targeted inflation level. This adjustment may involve changing interest rates or other tools at their disposal.

Step by step solution

01

Understanding Inflation

Inflation refers to a general increase in prices over a period of time and reflects a decrease in the purchasing value of money. It is usually measured as an annual percentage increase.
02

Monetary Policy Basics

Central banks, like the Federal Reserve in the United States or the European Central Bank in the Eurozone, implement monetary policies to regulate the money supply, manage interest rates, control inflation, stabilize the economy, and promote employment.
03

Targeting Inflation

Inflation targeting is an economic policy in which a central bank publicly commits to achieving and maintaining an inflation at a specified level or within a certain range. Targets are typically measured and announced in terms of an annual percentage.
04

Monitoring Inflation

The central bank uses economic data and indicators to monitor the inflation level. This data would commonly include price indices, such as the Consumer Price Index (CPI) or the Producer Price Index (PPI).
05

Adjusting Monetary Policy

Based on the results from monitoring inflation, the central bank adjusts its monetary policy to maintain the inflation within its target. This adjustment may include changing interest rates, open market operations, or reserve requirements.

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Most popular questions from this chapter

Explain how it is possible to have too much money.

Explain how the Keynesian transmission mechanism works.

Explain how a gold standard, as monetary policy, would work.

Argue the case for and against a monetary rule.

Consider the following: Two researchers, \(\mathrm{A}\) and \(\mathrm{B}\), are trying to determine whether eating fatty foods leads to heart attacks. The researchers proceed differently. Researcher A builds a model in which fatty foods may first affect \(\mathrm{X}\) in one's body, and if \(\mathrm{X}\) is affected, then \(\mathrm{Y}\) may be affected, and if \(\mathrm{Y}\) is affected, then \(\mathrm{Z}\) may be affected. Finally, if \(Z\) is affected, the heart is affected, and the individual has an increased probability of suffering a heart attack. Researcher B doesn't proceed in this step-by-step fashion. She conducts an experiment to see whether people who eat many fatty foods have more, fewer, or the same number of heart attacks as people who eat few fatty foods. Which researcher's methods have more in common with the research methodology implicit in the Keynesian transmission mechanism? Which researcher's methods have more in common with the research methodology implicit in the monetarist transmission mechanism? Explain your answer.
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