Monetary policy

What is inflation targeting?

A monetary policy in which a central bank has an explicit target inflation rate for the medium term

What two types of inflation targets are there?

• Symmetric, deviations above and below are given equal weight

• asymmetric, deviations below are seen to be less important than above

What are inflationary expectations?

Rate of inflation that workers, business and investors think will prevail in the future, and that they will therefore factor into their decision making.

What are the benefits of inflation targeting?

• transparency and accountability, further enhanced when central banks publish the reasons for their decisions

• expectations, if a target is credible then economic agents will adapt their expectations

• macro-economic stability, certainty allows AD and LRAS to expand

What are the problems with inflation targeting?

• targets must be credible

• requires effective forecasting, changes in policy can take 18 months-2 years

• asymmetric targets may build in a deflationary bias, deflation can be just as damaging

What is QE?

A monetary policy instrument where the central bank buys financial assets in exchange for money in order to increase lending/borrowing.

What is a bond?

Financial assets issued by the government as a way to borrow, these work on a fixed interest rate.

What is a bond yield?

The rate of interest received by those holding the bond.

Interest/bond price

What are the steps in QE?

central bank creates electronic money- uses money to buy bonds- increased liquidity(increased C and I)- increased demand for bonds- increased price creating a wealth effect- decreased bond yields- lower interest rates- removes deflationary expectations.

How does QE lead to higher AD?

• lower interest rates

• wealth effect

• removes deflationary expectations

What are the evaluative point for QE?

• confidence can remain low

• possibly inflationary

• the classical argument

What is the relationship between bonds and other financial assets like shares?

E.G. someone buys £1 million of government bonds from an asset manager, that manager now has £1 million allowing them to invest in other areas which pushes up the value of those assets

What are the steps of QT?

bank sells bonds on an open market- increases supply which decreases price- increased bond yields- decrease in AD