Tiểu luận môn đầu tư tài chính monetary police theory

O ur analysis of this monetary policy response shows that in the case of aggregate demand shocks, there is no tradeoff between the pursuit of price stability and economic activity stabil

Học viên: Trần Thị Thanh Thủy

Võ Thị Trúc Xuân Lớp: TC03 GV hướng dẫn: TS Trần Ngọc Thơ

University of Economics Ho Chi Minh City

- P review

- R esponse of Monetary Policy to Shocks

- A pplication: Quantitative (Credit) Easing in Response to the Global Finamcial Crisis

- H ow Actively Should Policymakers Try To Stabilze Economic Activity?

- I nflation: Always and Everywhere – A Monetary Phenomenon

- Causes Of Inflationary Monetary Policy

- A pplication: The Great Inflation

- S ummary

- E xpansion

Inflation has become a major concern of politicians and the public, and how to control it frequently dominates the discussion of economic policy.

In this chapter, we use the aggregate demand–aggregate supply (AD/AS) framework developed in Chapter 22 to develop a theory of monetary policy Specifically, we will examine the role of monetary policy in creating inflation and stabilizing the economy

We apply the theory to three big questions:

- What are the roots of inflation?

- Does stabilizing inflation stabilize output?

- Should policy be activist—by responding aggressively to fluctuations in economic activity—or passive and

nonactivist?

Th e central goal of central banks is price stability: that is, they try to maintain inflation,, close to a target level (), referred to as an inflation target, that is slightly above zero Most central banks set between 1% and 3%

A n alternative way to think about how the central bank pursues price stability is that monetary policy should try to minimize the difference between inflation and the inflation target

( - ), which we refer to as the inflation gap.

C entral banks also care about stabilizing economic activity Because economic activity can be sustained only at potential output, this objective of monetary policy can be described as saying that monetary policymakers want to have aggregate output

close to its potential level, YP Another way of saying this is that

central banks want to minimize the difference between aggregate

output and potential output (Y − YP), i.e., the output gap.

w e examined three categories of economic shocks—demand shocks, temporary supply shocks, and permanent supply shocks—and the consequences of each on inflation and output

I n this section, we describe a central bank’s policy responses, given its objectives, to each of these shocks In the case of both demand shocks and permanent supply shocks, policymakers can simultaneously pursue price stability and stability in economic activity

achieve either price ability or economic activity stability, but not both This tradeoff poses a thorny dilemma for central banks with dual andates.

W e begin by considering the effects of an aggregate demand shock, such as the disruption to financial markets starting in August 2007 that increased financial frictions and caused both consumer and business spending to fall

Th e economy is initially at point 1, where output is at YP and

inflation is at The negative demand shock decreases aggregate

demand, shifting AD1 in Figure 1 to the left to AD2

Policymakers can respond to this shock in two possible ways

H ere, aggregate output falls to Y2 below potential output YP,

and inflation falls to 2, below the inflation target of T

N o P olicy R esponse

W ith output below potential, slack begins to develop in the labor and product markets, lowering inflation The short-run aggregate supply curve will shift down

and to the right to AS3, and the economy will move to point 3 Output will again

be back at its potential level, while inflation will fall to a lower level of π3

A t first glance, this outcome looks favorable—inflation is lower and output is back at its potential But aggregate output will remain below potential for some time, and if inflation was initially at its target level, the fall in inflation is undesirable.

N o P olicy S tabilizes E conomic A ctivity A nd I nflation in the Sh ort R un

Policymakers can eliminate both the output gap and the inflation gap in the short run

bypursuing policies to increase aggregate demand to its initial level and return the economy to its preshock state The central bank does this by autonomously easing monetary policy by cutting the real interest rate at any given inflation rate

This action stimulates investment spending and increases the quantity of aggregate

output demanded at any given inflation rate, thereby shifting the AD curve to the right As a result, the aggregate demand curve shifts from AD2 back to AD1 in Figure

2, and the economy returns to point 1.

O ur analysis of this monetary policy response shows that in the case of aggregate demand shocks, there is no tradeoff between the pursuit of price stability and economic activity stability A focus on stabilizing inflation leads to

exactly the right monetary policy response to stabilize economic activity

N o conflict exists between the dual objectives of stabilizing inflation and

economic activity, which Olivier Blanchard (formerly of MIT, but now at the

International Monetary Fund) referred to as the divine coincidence

financial frictions rose dramatically ( fc )

The higher real cost of borrowing led to a decline in consumption expenditure and planned investment spending,

thereby causing a sharp contraction in aggregate demand and a leftward shift of the aggregate demand curve to AD2, as in

Figure 2

Although the Federal Reserve autonomously lowered the federal funds rate to the zero-lower bound, this was

insufficient to shift the aggregate demand curve back to AD1 By engaging in asset purchases and liquidity provision, the Fed was able to reduce financial frictions ( fT ) and lower the real cost of borrowing to households and businesses.

The result was that the aggregate demand curve did shift out to the right as shown in Figure 2,

thereby avoiding deflation and boosting economic activity so that the economy did not enter a depression, as in the 1930s

However, the negative aggregate demand shock to the economy from the global financial crisis

was so great that the Fed’s quantitative (credit) easing was insuffi-cient to overcome it, and the Fed was

unable to shift the aggregate demand curve all the way back to AD1

Hence, despite the Federal Reserve’s efforts, the economy still suffered a severe recession, with

inflation falling below the 2% level.

We illustrate a permanent supply shock in Figure 3 Again the economy starts out at point

1, where aggregate output is at the natural rate YP1 and inflation is at

Suppose the economy suffers a permanent negative supply shock because an increase in

regulations permanently reduces the level of potential output Potential output falls from YP1 to

YP 3, and the long-run aggregate supply curve shifts leftward from LRAS1 to LRAS3

The permanent supply shock triggers a price shock that shifts the short-run aggregate

supply curve upward from AS1 to AS2 Two possible policy responses to this permanent supply

shock are possible

Response to a permanent Supply Shock

N o P olicy R esponse

If policymakers leave autonomous monetary policy un- changed, the economy will move to point

2, with inflation rising to p2 and output falling to Y2

Because this level of output is still higher than potential output, YP3, the short-run aggregate

supply curve keeps shifting up and to the left until it reaches AS3, where it intersects AD1 on LRAS3

The economy moves to point 3, eliminating the output gap but leaving inflation higher at π3 and

output lower at YP3.

N o P olicy R esponse

We illustrate a permanent supply shock in Figure 3 Again the economy starts out at point

1, where aggregate output is at the natural rate YP1 and inflation is at

Suppose the economy suffers a permanent negative supply shock because an increase in

regulations permanently reduces the level of potential output Potential output falls from YP1 to

YP 3, and the long-run aggregate supply curve shifts leftward from LRAS1 to LRAS3

The permanent supply shock triggers a price shock that shifts the short-run aggregate

supply curve upward from AS1 to AS2 Two possible policy responses to this permanent supply

shock are possible

P olicy Stabilizes Inflation

According to Figure 4, monetary authorities can keep inflation at the target

inflation rate and stabilize inflation by decreasing aggregate demand

The goal is to shift the aggregate demand curve leftward to AD3, where it

intersects the long-run aggregate supply curve LRAS3 at the target inflation rate

of πT To shift the aggregate demand to AD3, the monetary authorities would

autonomously tighten monetary policy by increasing the real interest rate at any given inflation rate, thus causing investment spending to fall and lowering aggregate demand at any given inflation rate

The economy thus goes to point 3, where the output gap is zero and

inflation is at the target level of πT

Response to a permanent Supply Shock

P olicy Stabilizes Inflation

Here again, keeping the inflation gap at zero leads to a zero output gap, so

stabilizing inflation has stabilized economic activity.

The divine coincidence still remains true when a permanent supply shock occurs:

There is no tradeoff between the dual objectives of stabilizing inflation and economic activity.

   

 

 

1  

Response to a temprorary Supply Shock

When a supply shock is temporary, such as when the price of oil surges because of

political unrest in the Middle East or because of an act of god, such as a devastating hurricane in Florida, the divine coincidence does not always hold

Policymakers face a short-run tradeoff between stabilizing inflation and economic

activity To illustrate, we start the economy at point 1 in Figure 5, where aggregate output is at

the natural rate YP and inflation is at πT

The negative supply shock, say, a rise in the price of oil, shifts the short-run aggregate

supply curve up and to the left from AS1 to AS2 but leaves the long-run aggregate supply curve

unchanged because the shock is temporary

The economy moves to point 2, with inflation rising to π2 and output falling to Y2

Policymakers can respond to the temporary supply shock in three possible ways.

Response to a temprorary Supply Shock

No Policy Response

One policy choice is not to make an autonomous change in monetary policy, so the aggregate demand

curve does not shift Since aggregate output is less than potential output YP, eventually the short-run

back down to the right, returning to AS1

The economy will return to point 1 in Figure 5 and close both the output and inflation gaps, as output and

inflation return to the initial levels of YP and πT

No Policy Response

Both inflation and economic activity stabilize over time In the long run, there is no tradeoff between the two objectives, and the divine coincidence holds While we wait for the long run, however, the economy

will undergo a painful period of reduced output and higher inflation rates

This opens the door to monetary policy to try to stabilize economic activity or inflation in the short run.

   

Policy Stabilizes Inflation in the Short Run

A second policy choice for monetary authorities is to keep inflation at the target level of πT in the short

run by autonomously tightening monetary policy and raising the real interest rate at any given inflation rate

Doing so would cause investment spending and aggregate demand to fall at each inflation rate, shifting the

aggregate demand curve to the left to AD3 in Figure 6

The economy now moves to point 3, where the aggregate demand curve, AD3, intersects the short-run

aggregate supply curve AS2 at an inflation rate of πT.

Response to a temprorary Supply Shock

Policy Stabilizes Inflation in the Short Run

Because output is below potential at point 3, the slack in the economy shifts the short-run aggregate

supply curve back down to AS1

To keep the inflation rate at πT, the monetary authorities will need to move the short-run aggregate

demand curve back to AD1 by reversing the autonomous tightening and eventually, the economy will return to

point 1

Policy Stabilizes Inflation in the Short Run

A s Figure 6 illustrates, stabilizing inflation reduces aggregate output to Y3 in the

short run, and only over time will output return to potential output at YP

S tabilizing inflation in response to a temporary supply shock has led to a larger

deviation of aggregate output from potential, so this action has not stabilized economic activity.

   

Policy Stabilizes Economic Activity in the Short Run

A third policy is for monetary policymakers to stabilize economic activity rather than inflation in the short run by increasing aggregate demand

A ccording to Figure 7, now they would shift the aggregate demand

curve to the right to AD3, where it intersects the short-run aggregate supply curve AS2 and the long-run aggregate supply at point 3

Response to a temprorary Supply Shock

Policy Stabilizes Economic Activity in the Short Run

To do this, they would have to autonomously ease monetary

policy by lowering the real interest rate at any given inflation rate

At point 3, the output gap returns to zero, so monetary policy has

stabilized economic activity However, inflation has risen to π3, which

is greater than πT, so inflation has not been stabilized

Stabilizing economic activity in response to a temporary supply

shock results in a rise in inflation, so inflation has not been stabilized.

   

The Bottom Line: the relationship Between Stabilizing Inflation and Stabilizing

economic activity

1 If most shocks to the economy are aggregate demand shocks or permanent aggregate

supply shocks, then policy that stabilizes inflation will also stabilize economic activity, even in the short run

2 If temporary supply shocks are more common, then a central bank must choose

between the two stabilization objectives in the short run

3 In the long run there is no conflict between stabilizing inflation and economic activity

in response to shocks.

All economists have similar policy goals (to promote high employment and price

stability), yet they often disagree on the best approach to achieve those goals

Suppose policymakers confront an economy that has high unemployment resulting from a

negative demand or supply shock that has reduced aggregate output

N onactivists believe wages and prices are very flexible, so the self-correcting mechanism is very rapid They

argue that the short-run aggregate supply curve will shift down, returning the economy to full employment very quickly, They thus believe government action is unnecessary to eliminate unemployment

Activists , many of whom are followers of Keynes and are thus referred to as Keynesians, regard the

self-correcting mechanism through wage and price adjustment as very slow because wages and prices are sticky

As a result, they believe it takes a very long time to reach the long run, agreeing with Keynes’s famous adage that

“In the long-run, we are all dead.” They therefore see the need for the government to pursue active policy to eliminate high unemployment when it develops

Lags and Policy Implementation

If policymakers could shift the aggregate demand curve instantaneously, activist policies could be used to

immediately move the economy to the full-employment level, as we have seen in the previous section

However, several types of lags prevent this immediate shift from occurring, and there are differences in the length of these lags for monetary versus fiscal policy

Lags and Policy Implementation

1 The Data Lag

The data lag is the time it takes for policymakers to obtain data indicating what is

happening in the economy

Accurate data on GDP, for example, are not available until several months after a given quarter is over.

Lags and Policy Implementation