5.9 Monetary policy and inflation targeting

how does the central bank implement monetary policy?

through changes in the policy interest rate which in turn affects the real interest rate, which therefore affects aggregate demand and output

do there necessarily need ot be two policymakers just bc there’s two types of policy?

no - not necessarily

until late 1980s, in most countries, central banks had little operational independence and gov controlled both (still does in china)

central bank independence

in 1990s, inflation targeting was adopted by central banks globally which led to a shift towards central bank independence - this meant they had independence but were also required to hit inflation targets

who sets the inflation target rate?

the gov - but central bank is required to maintain it

why did the shift to inflation targeting happen?

bc there was a period of high and volatile inflation globally —> trying to keep inflation stable seemed like a good idea

zero lower bound

the central bank can only lower the policy rate so much - they can’t lower it below zero because then they’d be paying people to give them money

**sometimes a policy rate of zero isn’t enough to get the economy going again so they have to use quantitative easing

quantitative easing

gov steps in w/ fiscal stimulus which aimed at reducing LONG RUN interest rates

**long run interest rates become tool used

if monetary policy is expansionary, what does this mean for the real interest rate

real interest rate decreases
if monetary policy = contractionary, real interest rate increases

what determines the long-run inflation rate?

the target inflation rate bc the central bank is tasked w/ keeping inflation around that rate - in the long run, the central bank will pull inflation rate back within a narrow range of the target inflation rate

3 entities of federal reserve

(1) board of governors - 7 appointed by pres, approved by senate

(2) 12 Federal Reserve Banks - 12 regions

(3) Federal Open Market Committee - 12 ppl = 7 bogs + 5 of 12 FRB presidents

**federal open market committee decides interest rates

who does the federal reserve bank answer to?

technically, the federal reserve bank answers to congress and congress is repsonsible for them but they don’t have to do what congress wants or what the president wants - they’re tasked w/ keeping inflation at a certain rate and maintaining stability in the financial system, and employing monetary policy, not w/ political popularity

**they’re also financially stable based on the interest they make off of gov bonds that they manage