Chapter 20 Book Notes
Monetary Policy: The Best Case
Fixing the Real Growth Rate: The Fed Problems
1. The Federal Reserve must operate in real time when much of the data about the state of the
economy is unknown.
2. The Federal Reserve’s control of the money supply is incomplete and subject to uncertain lags.
Reversing Course and Engineering a Decrease in AD
Sometimes economics can be stuck between a rock and a hard place
- Ronald Regan reducing inflation over 10%, but increasing unemployment to 10%
o The disinflation was costly
▪ Significant reduction in the rate of inflation
▪ On purpose
- Great Depression
o The deflation was an accident
▪ Decrease in prices, that is, a negative inflation rate
- Is a contraction a promising idea?
o A monetary contraction goes best when it is credible
▪ When it is expected that a central bank will stick with its policy
▪ Should explain actions publicly
The Fed as Manager of Market Confidence
- The Fed’s biggest responsibility is to boost market confidence
o Most powerful tool, is its influence over expectations, not its influence over the money
- Uncertainty drives people away from investment spending and toward assets like cash
o Not very production
- After the 9/11 attacks the Federal Reserve lent about $45.5 billion to banks, only $34 million the
o To prevent people becoming uncertain
▪ Raise confidence, reduce fear
The Negative Real Shock Dilemma
- What is the answer to reducing inflation?
o Decreasing M, reducing aggregate demand
- Is it worthwhile responding to a real shock with an increase in AD?
o Maybe not. It’ll increase growth rate by a little, and inflation by a lot - With a real shock the central bank faces a dilemma
o Must choose between too low a rate of growth (with a high unemployment)
o OR too high of an inflation rate
When the Fed Does Too Much