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Chapter 17: Q. 20 (page 468)

What are the main criteria for choosing a policy instrument? Why? Explain.

Short Answer

Expert verified

Observability and measurability

Controllability
Predictable effects on goal

Step by step solution

01

Concept Introduction

Policy instruments are techniques used by central banks or governments to promote a policy. For instance, in a fiscal policy, government spending and taxation are policy instruments.

02

Explanation

Observability and measurability

By implementing a policy whose effects can be observed easily and measured accurately, the impacts of the policy can be tracked and changed if needed.
Controllability
If a policy has too little or too hard of an effect, it can be adjusted in scale to properly reach an outcome.
Predictable effects on goal
By having policies with straightforward outcomes it'll be easier to measure, control, and predict how to apply, how intensely, and for how long.

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Most popular questions from this chapter

What procedures can the Fed use to control the federal funds rate? Why does control of this interest rate imply that the Fed will lose control of nonborrowed reserves?

What are the key advantages and disadvantages of the monetary strategy used by the Federal Reserve under Alan Greenspan, in which the nominal anchor was implicit rather than explicit?

. Since monetary policy changes made through the fed funds rate occur with a lag, policymakers are usually more concerned with adjusting policy according to changes in the forecasted or expected inflation rate, rather than the current inflation rate. In light of this, suppose that monetary policymakers employ the Taylor rule to set the fed funds rate, where the inflation gap is defined as the difference between expected inflation and the target inflation rate. Assume that the weights on both the inflation and output gaps are ½, the equilibrium real fed funds rate is 4%, the inflation rate target is 3%, and the output gap is 2%. a. If the expected inflation rate is 7%, then at what target should the fed funds rate be set according to the Taylor rule?

b. Suppose half of Fed economists forecast inflation to be 6%, and half of Fed economists forecast inflation to be 8%. If the Fed uses the average of these two forecasts as its measure of expected inflation, then at what target should the fed funds rate be set according to the Taylor rule?

c. Now suppose half of Fed economists forecast inflation to be 0%, and half forecast inflation to be 14%. If the Fed uses the average of these two forecasts as its measure of expected inflation, then at what target should the fed funds rate be set according to the Taylor rule?

d. Given your answers to parts (a)–(c) above, do you think it is a good idea for monetary policymakers to use a strict interpretation of the Taylor rule as a basis for setting policy? Why or why not?

What methods have inflation-targeting central banks used to increase communication with the public and to increase the transparency of monetary policymaking?

“Because inflation targeting focuses on achieving the inflation target, it will lead to excessive output fluctuations.” Is this statement true, false, or uncertain? Explain.
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