Financial Markets, Banking, and Monetary Policy

CHAPTER 14 Monetary Policy: Challenges Faced by Policymakers

WHAT YOU WILL LEARN IN THIS CHAPTER

• The kinds of shocks to aggregate demand and aggregate supply that push the economy off course and require central bank action.
• The critical role played by expectations when inflation departs from the central bank’s objectives.
• The time lags involved between the time the economy or inflation move off course and actions taken by the central bank begin to correct the situation.
• How these lags require the central bank to be forward looking in setting its policy.
• The potential benefits from having the central bank follow a well-articulated monetary policy rule instead of discretion.
• How central banks have used forward guidance to increase the effectiveness of their actions.
• How central bank credibility is critical to its effectiveness in stabilizing inflation and output and employment, and how central bank independence buttresses credibility.
• Whether there would be gains to be achieved if the United States were to follow the lead of other countries and have a single goal of inflation instead of its current dual mandate.
• How the Fed has utilized conventional and unconventional monetary policy tools to counter the Great Recession.

BACKGROUND

Perhaps you thought from the discussion of the previous chapter that central banking isn’t so difficult after all. You need to figure out where the economy is in relation to potential output and engineer policy settings that place aggregate demand ...