Monetary Theory And Policy at Universität Mannheim | Flashcards & Summaries

Lernmaterialien für Monetary Theory and Policy an der Universität Mannheim

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TESTE DEIN WISSEN
Inflation targeting
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TESTE DEIN WISSEN
• Inflation targeting is a central bank strategy of specifying an inflation rate as a goal and adjusting monetary policy to achieve that rate.
• Inflation targeting primarily focuses on maintaining price stability, but is also believed by its proponents to support economic growth and stability.
Inflation targeting can be contrasted to other possible policy goals of central banking, including the targeting of exchange rates, unemployment, or national income.
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TESTE DEIN WISSEN
Fisher equation
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TESTE DEIN WISSEN
The equation reveals that monetary policy moves inflation and the nominal interest rate together in the same direction. On the other hand, monetary policy generally does not affect the real interest rate.
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TESTE DEIN WISSEN
What is the steady state?
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TESTE DEIN WISSEN
The steady state is where the model economy converges to
(stabilizes) in the absence of shocks
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TESTE DEIN WISSEN
Relationship between interest rate and savings
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TESTE DEIN WISSEN

Interest rates determine the amount of interest payments that savers will receive on their deposits.

  • An increase in interest rates will make saving more attractive and should encourage saving.
  • A cut in interest rates will reduce the rewards of saving and will tend to discourage saving.

However, in the real world, it is more complicated. The link between interest rates and saving is not clear because many factors affect saving


Income and substitution effect of higher interest rates.

  • If interest rates fall, the reward from saving falls. It becomes relatively more attractive to hold cash and/or spend. This is the substitution effect – with lower interest rates, consumers substitute saving for spending.
  • However, if interest rates fall, savers see a decline in income because they receive lower income payments. A pensioner relying on interest payments from saving may feel he needs to save more to maintain their target income from savings.

Usually, the substitution effect dominates. Lower interest rates make saving less attractive. But, for some, the income effect may dominate, and people may respond to lower interest rates by saving more to maintain their standard of living.

Alternatively, a lower interest rate may encourage other forms of saving and investment. With very low bank rates, it has encouraged people to look for better yields in the stock market. This is one reason why the stock market did well in the great recession of 2008-2013 – savers have been buying shares to get a better rate of interest rate than they can in a bank and on bonds

Lösung ausblenden
TESTE DEIN WISSEN
MIU model
Lösung anzeigen
TESTE DEIN WISSEN
-introduction of moneatry policy instrument in the neoclassical growth model
- money yields direct utility by incorporating money balances
- utility depends directly on consumption and real money balances
Lösung ausblenden
TESTE DEIN WISSEN
Steady state with constant money growth
Lösung anzeigen
TESTE DEIN WISSEN
SS values of consumption, capital and output (real variables ) independent of the growth rate of the nominal money stock -> independent of the inflation rate
- in SS thhe nominal interest rate and inflation are not growing because of constant money growth 
- in the long run real variables do not depend on money growth except of the real money balances
- MIU model is neutral in the long run
Lösung ausblenden
TESTE DEIN WISSEN
relation between money growth and inflation rate
Lösung anzeigen
TESTE DEIN WISSEN
-inflation is equal to money growth in the SS when money growth is constant 
Lösung ausblenden
TESTE DEIN WISSEN
the effect of non constant money gowth on real money balances
Lösung anzeigen
TESTE DEIN WISSEN
if money growth increases permanently (permanent shock) ->inflation increases -> nominal interest rate increases -> SS real money balances decrease (demand for money decrease ) -> marginal benefit of working increases -> leisure and consumption decrease
Lösung ausblenden
TESTE DEIN WISSEN
conditions of money neutrality in the MIU model
Lösung anzeigen
TESTE DEIN WISSEN
money superneutral if separable utilities -> inflation only induces a welfare loss due to lower money demand and therefore a decrease in utility

- changing money growth rule necessary to have an effect of money on real economy


non superneutrality if:
- add labor-leisure choice (exogenous labor supply)
- non separable utility (e.g. money and consumption are complements)
Lösung ausblenden
TESTE DEIN WISSEN
Friedman Rule: Optimal Rate of inflation
Lösung anzeigen
TESTE DEIN WISSEN
private cost of holding money depends on nominal interest rate
social marginal cost of producing money =0
-> if i>0 -> wedge between private and social costs -> inefficiency 
-> inefficiency eliminated if i=0

- i=0 required than inflation rate = -r
-> optimal money growth in SS is -r
Lösung ausblenden
TESTE DEIN WISSEN
Money growth shocks
Lösung anzeigen
TESTE DEIN WISSEN
persistency of money growth shocks matter for superneutrality of money 
->if money growth rises permanently (in t+1, t+2,...)-> HH's expect inflation to rise in the future (in t+1,...) -> expect nominal interest rate to rise -> money demand decreases at time t (anticipation) 
-> if utility is non separable and assume that marginal utility of consumption rises with real money, then the decrease in real money balances decreases marginal utility of consumption -> consumption and leisure increase -> labor supply and output fall (money not superneutral in case of non separability and labor leisure choice)

- after a permanent money growth shock, inflation increases and money demand decreases so inflation rises more than nominal money balances 
Lösung ausblenden
TESTE DEIN WISSEN
short and long run effects
Lösung anzeigen
TESTE DEIN WISSEN
- persistent money growth shocks have an impact on expected future inflation, increase nominal interest rate and therefore reduce money demand  and affect consumption and working decision -> if real money balances decrease die to increase in i, consumption and therefore output decrease -> people want to work less (only if money and consumption are complements -> non separable utility-> money is not superneutral
- if mone growth shock is not persistent money also neutral because economy returns back to steady state

- productivity shocks have an impact on real economy

- money growth is equal to inflation rate in the Steady state if money growth is constant and if the shock is persistent - not equal if shock is not persistent 
-> in the short run, inflation rate and mone growth are not equal (when there is a shock)
Lösung ausblenden
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Q:
Inflation targeting
A:
• Inflation targeting is a central bank strategy of specifying an inflation rate as a goal and adjusting monetary policy to achieve that rate.
• Inflation targeting primarily focuses on maintaining price stability, but is also believed by its proponents to support economic growth and stability.
Inflation targeting can be contrasted to other possible policy goals of central banking, including the targeting of exchange rates, unemployment, or national income.
Q:
Fisher equation
A:
The equation reveals that monetary policy moves inflation and the nominal interest rate together in the same direction. On the other hand, monetary policy generally does not affect the real interest rate.
Q:
What is the steady state?
A:
The steady state is where the model economy converges to
(stabilizes) in the absence of shocks
Q:
Relationship between interest rate and savings
A:

Interest rates determine the amount of interest payments that savers will receive on their deposits.

  • An increase in interest rates will make saving more attractive and should encourage saving.
  • A cut in interest rates will reduce the rewards of saving and will tend to discourage saving.

However, in the real world, it is more complicated. The link between interest rates and saving is not clear because many factors affect saving


Income and substitution effect of higher interest rates.

  • If interest rates fall, the reward from saving falls. It becomes relatively more attractive to hold cash and/or spend. This is the substitution effect – with lower interest rates, consumers substitute saving for spending.
  • However, if interest rates fall, savers see a decline in income because they receive lower income payments. A pensioner relying on interest payments from saving may feel he needs to save more to maintain their target income from savings.

Usually, the substitution effect dominates. Lower interest rates make saving less attractive. But, for some, the income effect may dominate, and people may respond to lower interest rates by saving more to maintain their standard of living.

Alternatively, a lower interest rate may encourage other forms of saving and investment. With very low bank rates, it has encouraged people to look for better yields in the stock market. This is one reason why the stock market did well in the great recession of 2008-2013 – savers have been buying shares to get a better rate of interest rate than they can in a bank and on bonds

Q:
MIU model
A:
-introduction of moneatry policy instrument in the neoclassical growth model
- money yields direct utility by incorporating money balances
- utility depends directly on consumption and real money balances
Mehr Karteikarten anzeigen
Q:
Steady state with constant money growth
A:
SS values of consumption, capital and output (real variables ) independent of the growth rate of the nominal money stock -> independent of the inflation rate
- in SS thhe nominal interest rate and inflation are not growing because of constant money growth 
- in the long run real variables do not depend on money growth except of the real money balances
- MIU model is neutral in the long run
Q:
relation between money growth and inflation rate
A:
-inflation is equal to money growth in the SS when money growth is constant 
Q:
the effect of non constant money gowth on real money balances
A:
if money growth increases permanently (permanent shock) ->inflation increases -> nominal interest rate increases -> SS real money balances decrease (demand for money decrease ) -> marginal benefit of working increases -> leisure and consumption decrease
Q:
conditions of money neutrality in the MIU model
A:
money superneutral if separable utilities -> inflation only induces a welfare loss due to lower money demand and therefore a decrease in utility

- changing money growth rule necessary to have an effect of money on real economy


non superneutrality if:
- add labor-leisure choice (exogenous labor supply)
- non separable utility (e.g. money and consumption are complements)
Q:
Friedman Rule: Optimal Rate of inflation
A:
private cost of holding money depends on nominal interest rate
social marginal cost of producing money =0
-> if i>0 -> wedge between private and social costs -> inefficiency 
-> inefficiency eliminated if i=0

- i=0 required than inflation rate = -r
-> optimal money growth in SS is -r
Q:
Money growth shocks
A:
persistency of money growth shocks matter for superneutrality of money 
->if money growth rises permanently (in t+1, t+2,...)-> HH's expect inflation to rise in the future (in t+1,...) -> expect nominal interest rate to rise -> money demand decreases at time t (anticipation) 
-> if utility is non separable and assume that marginal utility of consumption rises with real money, then the decrease in real money balances decreases marginal utility of consumption -> consumption and leisure increase -> labor supply and output fall (money not superneutral in case of non separability and labor leisure choice)

- after a permanent money growth shock, inflation increases and money demand decreases so inflation rises more than nominal money balances 
Q:
short and long run effects
A:
- persistent money growth shocks have an impact on expected future inflation, increase nominal interest rate and therefore reduce money demand  and affect consumption and working decision -> if real money balances decrease die to increase in i, consumption and therefore output decrease -> people want to work less (only if money and consumption are complements -> non separable utility-> money is not superneutral
- if mone growth shock is not persistent money also neutral because economy returns back to steady state

- productivity shocks have an impact on real economy

- money growth is equal to inflation rate in the Steady state if money growth is constant and if the shock is persistent - not equal if shock is not persistent 
-> in the short run, inflation rate and mone growth are not equal (when there is a shock)
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