What is the Lucas critique?
Policy evaluation is unreliable if models ignore changes in expectations.
How does the Lucas critique affect inflation policy?
Higher money growth may raise expected inflation without reducing unemployment.
Why do expectations matter for policy outcomes?
People change behavior when policy changes.
What is a policy rule?
A binding plan specifying how policy responds to data.
What is discretionary policy?
Policymaking without commitment to future actions.
What is the time-inconsistency problem?
Incentive to pursue short-run gains that harm long-run outcomes.
What is a nominal anchor?
A variable that anchors inflation or the price level.
Why is credibility important
It anchors inflation expectations and reduces output losses.
What happens if a central bank lacks credibility?
Inflation expectations remain high.
What is constrained discretion?
A mix of rules and flexibility in policymaking.
What are transmission mechanisms?
Channels through which monetary policy affects the economy.
What rate matters most for spending decisions?
The real long-term interest rate.
Can monetary policy work at zero nominal rates?
Yes, by managing expectations and real rates.
How does lower interest rates affect net exports?
Depreciation → higher NX.
What is Tobin’s q?
Market value of firms divided by replacement cost of capital.
What does q > 1 imply?
Firms increase investment.
What does q < 1 imply?
Invest less
What does q equal?
Market value of firms/ replacement cost of capital
How do stock prices affect consumption?
Higher prices increase wealth and consumption.
What causes financial frictions?
Asymmetric information.
What is the bank lending channel?
More reserves → more loans → higher spending.
What is the balance sheet channel?
Improved net worth reduces lending problems.
How does unexpected inflation affect borrowers?
Raises real net worth by reducing real debt.
Why are asset prices important for policy?
They transmit monetary policy effects.
