Download Name:

ECON 2020—Macroeconomics
Name:
s
Replace this text with your name
Assignment Designation:
Replace this text with the assignment designation (Chapter 14)
Question 1: Suppose that you are a member of the Board of Governors of the Federal Reserve
System. The economy is experiencing a sharp rise in the inflation rate. What change in the
Federal funds rate would you recommend? How would your recommended change get
accomplished? What impact would the actions have on the lending ability of the banking system,
the real interest rate, investment spending, aggregate demand, and inflation?
Answer: To reduce inflation, the Federal funds rate should be raised. This would be
accomplished typically through open-market operations (selling bonds), but could also be achieved
with an increase in the reserve ratio or discount rate.
The restrictive monetary policy would reduce the lending ability of the banking system,
increase the real interest rate, reduce investment spending, reduce aggregate demand, and reduce
inflation.
Question 2: What is “inflation targeting,” and how does it differ from “artful management?”
What are the main benefits of inflation targeting, according to its supporters? Why do many
economists feel it is unnecessary or even undesirable?
Answer: An inflation targeting policy would have the Fed announce each year a target range for
the rate of inflation. Fed policy would then be geared to pursue that objective, and failure to meet
the target would require the Fed to explain what went wrong. Artful management takes a broader
approach, giving the Fed the multiple objectives of not only price stability, but also cyclical stability,
high levels of employment, and economic growth. It relies more on a combination of sound
economic principles and the intuition of the Board of Governors.
Supporters of inflation targeting argue that it increases the transparency and accountability
of Fed policy. It would also keep the Fed focused on what should be its primary objective – stable
prices. Some supporters would also argue that the success of past Fed action does not ensure
that it will always make the right decision, especially if it attempts to pursue multiple objectives
simultaneously
.
Opponents of inflation targeting believe that the Fed needs the discretion and flexibility to
adapt policy to conditions that are changing (sometimes rapidly). They also believe that past
Page 1
ECON 2020—Macroeconomics
success in inflation, targeting is partially the result of ideal economic conditions, and opponents
question its effectiveness during more economically difficult times.
Page 2