Question 3(Section 13.4-13.7 ), 5(Section 13.11) & Analytical Question 1 Please

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Question 3(Section 13.4-13.7 ), 5(Section 13.11) & Analytical Question 1

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because it provides discretion as to how to respond to economic events, while still providing a rules-bascd framework to help promote credibility. In Section 13.8, we saw that central banks invariably use short-term market interest rates to implement monetary policy. The central bank has control over these because it is the only supplier of reserves to the banking system. Section 13.9 showed the equivalence, under some conditions, between targeting the money supply and an interest rate. In Section 13.10, we described a model of the transmission mechanism by which monetary policy affects demand directly by changing interest rates, asset prices and exchange rates, and affecting consumption, investment and exports. Additional effects work through changes in producer and consumer confidence. Furthermore, a credit channel is believed sometimes to affect the economy. This operates through changes in the supply and demand for credit that are not directly related to interest rates. Empirical estimates suggest that the effect of changing interest rates accumulates over time and takes years to have its peak impact. In setting interest rates, central bankers monitor a wide range of statistics. In Section 13.11, we introduced Taylor rules as a useful way of conceptualizing this process. Interest rates increase when the output gap is large and when inflation exceeds its target. Section 13.12 described the concept of quantitative easing, a policy that central banks adopt when interest rates are close to zero.Should something that has such a large impact on the economy as monetary policy be handed over to a central bank rather than being decided by elected politicians? Central banks control short-term interest rates because they control the supply of base money, which is the ultimate, final form of settlement for transactions. Are central banks abusing this power by using it to determine interest rates? Why not specify a goal for the monetary authorities that includes both a price level and an unemployment target? Should measures of inflation include asset prices (e.g. stock prices and house prices) so that inflation targeting would require the monetary authorities to act when asset prices rise dramatically? At Christmas and Easter members of the public withdraw large amounts of cash from their accounts. What should central banks do during these periods to stabilize interest rates? Should central banks use Taylor rules to set monetary policy? Has quantitative easing been effective? Use the IS-LM apparatus to show' how the change in the level of interest rates needed to bring about a given change in demand is greater, the less responsive investment and consumption are to the cost of borrowing. Use the IS-LM framework to show that the level of interest rates needed to preserve demand at some given level might require negative interest rates. The Federal Reserve Bank of Albion operates a Taylor rule of Interest rate = Inflation target + Equilibrium real interest rale + (0.5 X Output gap)+ [1.5 X (Inflation - Inflation target)]

Explanation / Answer

price stability (1st question)

The fundamental task of the central bank is to preserve the value of the currency. The understanding of the centrality of price stability has evolved over the years, and it is worthwhile to review selectively recent developments in thinking about this aspect of the role of the central bank, with an emphasis on unsettled and controversial issues.

As long as countries adhered to the gold standard, rapid inflations were precluded, although prolonged movements in the inflation rate were evident in the 19th century. But, the gold standard has two fundamental disadvantages: It makes the growth rate of the monetary base (currency held outside banks plus banks' claims on the central bank) dependent on the vagaries of the supply of gold; and it is a costly way of producing money

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