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ec 250 November 26.docx

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November 26, 2013 EC250 10.3.5 Costs of Deflation -little difference in price change with moderate inflation and deflation Benefits of moderate inflation -easier to reduce real wage -central bank can lower the real interest rates more 10.4 Central Bank Independence -borad of bank appointed longer than government term -central bank manages monetary policy without interference from the elected officials Rules versus discretion Time consistent: if the rest of the plan is unchanged Time inconsistent: if the rest of the plan changes Examples of time inconsistent 1. Building restrictions in hurricane 2. Taxation of fixed assets (capital cannot run away but leisure can) 3. Exams 4. Monetary Policy Example Zimbabwe where the government does not care about the future of the country Monetary policy time inconsistent -central bank has incentive to raise inflation above what is expected =lower real interest rate = higher demand = lower unemployment =central bank follows discretionary policy = people will not believe promises of low inflation Solution = rule -goal = central bank to have low inflation -bank is independent -policy makers are evaluated on basis of inflation performance Example: Professor makes you believe that there will an exam which stimulates you to study Evaluation -too inflexible = central bank must be able to react to other variables Canada Independent The directive: Fundamental disagreement, Minister of Finance will issue a directive. The governor will follow the directive and will resign = not likely to happen 1. Governor like the job = would not risk by disagree publicly with M.O.F Minister of Finance will give them a call to direct them (behind closed doors where citizens do not know about this) 2. Minister of Finance (official document to talk about the resign, therefore will call M.O.F) to see what they want to do Zero Bound on Interest Rates and Monetary Policy in Great Recession -short term nominal interest rates were around zero and not below it Approaches 1. Quantitative easing: large scale of purchases of long term asset in market Goal: increase price of long term asset and flatten term structure (reduce interest rates) Problem: money supply increase European central bank does a lot of this 2. Operation twist: central bank buys long term asset and sells short term asset -price of long term asset increase, price of short term asset fall -long term in
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