Argument for Raising Inflation Targets to Mitigate ZLB Risks
To minimize the risk of the economy being constrained by the zero lower bound and experiencing prolonged deflation, some economists propose raising inflation targets. For example, increasing the target from 2% to 4% would generally lead to higher nominal interest rates during stable periods. This provides the central bank with more room to lower its policy rate during an economic slump before hitting the zero floor, enhancing its ability to stimulate the economy.
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Introduction to Macroeconomics Course
Ch.4 Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Ch.5 Macroeconomic policy: Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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Argument for Raising Inflation Targets to Mitigate ZLB Risks
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Argument for Raising Inflation Targets to Mitigate ZLB Risks
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A central bank has a publicly announced objective to keep the annual increase in consumer prices at 2%. Currently, price levels are rising at exactly this rate. However, a sudden loss of international investor confidence has caused the nation's currency to rapidly lose value on foreign exchange markets. Faced with these two developments, which policy response would be most consistent with the bank's stated framework?
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A central bank operating under an inflation targeting framework must prioritize keeping the country's exchange rate stable, even if it means inflation temporarily deviates from its official target.
A central bank has a stated objective of keeping annual inflation at 2%. Current economic reports indicate that the annual inflation rate is 0.5% and the unemployment rate is significantly above its long-run sustainable level. To achieve its objective, which of the following actions is the central bank most likely to implement?
A central bank has successfully maintained an average annual price increase of 2% for the past fifteen years, in line with its publicly stated objective. A sudden, temporary disruption to global supply chains causes the rate of price increases to jump to 6% in the current year. If households and firms believe the central bank will adhere to its long-term objective, how will this belief most likely influence their economic behavior?
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Figure 5.6: Unemployment, NAIRU, and Inflation in Canada (1985–2022)
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Learn After
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Two economies, Country A and Country B, have historically stable prices but different monetary policy goals. Country A's central bank targets 2% inflation, while Country B's targets 4% inflation. Both economies enter an identical, severe economic slump. Assuming both central banks rely solely on cutting their main policy interest rate to stimulate the economy, which statement best analyzes the situation?
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Consider an economy where the central bank's main policy interest rate cannot be lowered any further. A proposal to permanently increase the long-term inflation goal from 2% to 4% is based on the reasoning that, in future economic downturns, this change would give the central bank less capacity to provide stimulus by adjusting its policy rate.
A central bank operates in an economy where the long-run equilibrium policy interest rate is typically 2 percentage points above the official inflation target. A severe economic downturn occurs, and economists estimate that a 5 percentage point reduction in the policy interest rate is needed to effectively stimulate the economy. Which of the following inflation targets would allow the central bank to implement the full required stimulus without its policy being constrained by the fact that interest rates cannot fall below zero?
An economy's central bank typically sets its main policy interest rate 2 percentage points above its official inflation target during periods of economic stability. The policy rate cannot be lowered below zero. Match each potential inflation target with the maximum possible reduction in the policy interest rate that the central bank can implement during an economic downturn.
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