What is the time-inconsistency problem?
Policymakers have incentives to pursue short-run expansion, leading to higher inflation without long-run output gains.
How does a nominal anchor reduce time inconsistency?
It commits policymakers to price stability, making inflation expectations credible.
Give two examples of nominal anchors.
Inflation target, money supply growth target.
What characterizes the short run in macroeconomics?
Shocks, sticky prices/wages, and expectation errors.
What characterizes the long run?
Flexible prices, correct expectations, and no exogenous shocks.
Is output at potential GDP in the short run?
No.
What is potential GDP?
The level of output when resources are fully and sustainably employed.
Is money neutral in the short run?
Not necessarily.
Why do central banks care about financial market stability?
Instability can disrupt credit and reduce economic activity.
Why might central banks want interest-rate stability?
Large fluctuations increase uncertainty and discourage investment.
What is a hierarchical mandate?
Price stability has priority over other goals.
What is a dual mandate?
Price stability and maximum employment are coequal objectives.
Why is price stability still the primary long-run goal under both mandates?
Other goals cannot be achieved sustainably without stable prices.
What is the typical inflation target in advanced economies?
Around 2%.
Why does inflation targeting increase transparency?
Central banks clearly explain goals and policy decisions.
Why might inflation targeting increase output volatility?
Strict focus on inflation may limit response to real shocks.
What does “information-inclusive” mean?
Policymakers consider many economic indicators, not just inflation.
Why is cleaning up financial crises costly?
Output losses and unemployment persist for many years.
Why did the zero lower bound become a problem?
Interest rates could not be reduced enough to stimulate demand.
What new concern did the crisis raise for inflation targeting?
Financial stability must be considered explicitly.
What defines an asset-price bubble?
Asset prices rise far above fundamental values and then crash.
Why are bubbles hard to identify?
Fundamental values are uncertain and change over time.
What is the “lean vs clean” debate?
Whether central banks should prevent bubbles (lean) or clean up after they burst.
What is macroprudential policy?
Regulation aimed at reducing systemic risk in the financial system.
