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CHAPTER 21
Monetary Policy Strategies
1.A nominal anchor helps promote price stability by tying inflation expectations to low levels directly through its constraint on the value of money. It can also limit the time-inconsistency problem by providing an expected constraint on monetary policy.
3.Central bankers might think they can boost output or lower unemployment by pursuing overly expansionary monetary policy even though in the long run this just leads to higher inflation and no gains on the output or unemployment front. Alternatively, politicians may pressure the central bank to pursue overly expansionary policies.
5.German reunification produced tight monetary policy in Germany which raised interest rates for the other ERM countries because their currencies were pegged to the German mark. The high interest rates then slowed economic growth and increased unemployment in the other countries.
7.Emerging market countries may not lose much by giving up the ability to pursue an independent monetary policy because they are unable to do monetary policy well as a result of weak political or monetary institutions.
9.Exchange rate targeting is likely to be a sensible strategy for industrialized countries when domestic monetary and political institutions are not conducive to good monetary policymaking, and when there are other important benefits of an exchange rate target that have nothing to do with monetary policy. Exchange rate targeting is likely to be sensible for emerging market countries whose political and monetary institutions are weak so that it is the only way to break inflationary psychology and stabilize the economy.
11.Dollarization has the advantage that there is no possibility of a speculative attack. Dollarization has the disadvantage that it results in the loss of seignorage, the revenue to the government from having its own currency.
13.Monetary targeting it only works well if there is a reliable relationship between the monetary aggregate and inflation, a relationship that has often not held in different countries.
15.Sustained success in the conduct of monetary policy as measured against a pre-announced and well-defined inflation target can be instrumental in building public support for a central bank’s independence and for its policies. Also inflation targeting is consistent with democratic principles because the central bank is more accountable.
17.False. Inflation targeting does not imply a sole focus on inflation. In practice, central banks do worry about output fluctuations and inflation targeting may even be able to reduce output fluctuations because it allows monetary policymakers to respond more aggressively to declines in demand because they don’t have to worry that the resulting expansionary monetary policy will lead to a sharp rise in inflation expectations.
19.This strategy has the following advantages: (1) it enables monetary policy to focus on domestic considerations, (2) it does not rely on a stable money-inflation relationship, and(3) it has had a demonstrated success, producing low inflation with the longest business cycle expansion since World War II. However, it has the following disadvantages: (1) it has a lack of transparency,(2) it is strongly dependent on the preferences, skills, and trustworthiness of individuals in the central bank and the government; and (3) it has some inconsistencies with democratic principles because the central bank is not highly accountable.