Fiscal and Monetary Policy. Fiscal and Monetary Policy The Nature of Fiscal Policy.

Fiscal andMonetary Policy

Fiscal and Monetary PolicyFiscal and Monetary Policy

The Nature of Fiscal Policy

The Nature of Fiscal Policy

THE NATURE OF FISCAL POLICYTHE NATURE OF FISCAL POLICY

The purpose of fiscal policy correcting a fundamental disequilibrium

fine tuning

Government finances budget deficits and surpluses

financing a deficit

the PSNCR


fine tuning


financing a deficit

the PSNCR

UK public-sector deficits/surpluses: 1979–2001

Year 1979 1980 1981 1982 1983 1984

PSNCR (£bn) 12.5 11.4 10.6 5.3 11.1 10.3

% of GDP 6.3 5.0 4.2 1.9 3.7 3.2

Year 1985 1986 1987 1988 1989 1990

PSNCR (£bn) (–ve = surplus) 7.6 2.6 –1.2 –11.5 –9.1 –1.3

% of GDP (–ve = surplus) 2.1 0.7 –0.3 –2.4 –1.8 –0.2

Year 1991 1992 1993 1994 1995 1996

PSNCR (£bn) 7.0 28.6 43.2 39.4 35.4 24.8

% of GDP 1.2 4.7 6.7 5.8 4.9 3.3

Year 1997 1998 1999 2000 2001

PSNCR (£bn) (–ve = surplus) 11.9 –6.4 –1.8 –37.3 –2.7

% of GDP (–ve = surplus) 1.5 –0.7 –0.2 –4.0 –0.3


Year 1979 1980 1981 1982 1983 1984

PSNCR (£bn) 12.5 11.4 10.6 5.3 11.1 10.3

% of GDP 6.3 5.0 4.2 1.9 3.7 3.2

Year 1985 1986 1987 1988 1989 1990


% of GDP (–ve = surplus) 2.1 0.7 –0.3 –2.4 –1.8 –0.2

Year 1991 1992 1993 1994 1995 1996

PSNCR (£bn) 7.0 28.6 43.2 39.4 35.4 24.8

% of GDP 1.2 4.7 6.7 5.8 4.9 3.3

Year 1997 1998 1999 2000 2001


% of GDP (–ve = surplus) 1.5 –0.7 –0.2 –4.0 –0.3


Year 1979 1980 1981 1982 1983 1984

PSNCR (£bn) 12.5 11.4 10.6 5.3 11.1 10.3

% of GDP 6.3 5.0 4.2 1.9 3.7 3.2

Year 1985 1986 1987 1988 1989 1990


% of GDP (–ve = surplus) 2.1 0.7 –0.3 –2.4 –1.8 –0.2

Year 1991 1992 1993 1994 1995 1996

PSNCR (£bn) 7.0 28.6 43.2 39.4 35.4 24.8

% of GDP 1.2 4.7 6.7 5.8 4.9 3.3

Year 1997 1998 1999 2000 2001


% of GDP (–ve = surplus) 1.5 –0.7 –0.2 –4.0 –0.3


Year 1979 1980 1981 1982 1983 1984

PSNCR (£bn) 12.5 11.4 10.6 5.3 11.1 10.3

% of GDP 6.3 5.0 4.2 1.9 3.7 3.2

Year 1985 1986 1987 1988 1989 1990


% of GDP (–ve = surplus) 2.1 0.7 –0.3 –2.4 –1.8 –0.2

Year 1991 1992 1993 1994 1995 1996

PSNCR (£bn) 7.0 28.6 43.2 39.4 35.4 24.8

% of GDP 1.2 4.7 6.7 5.8 4.9 3.3

Year 1997 1998 1999 2000 2001


% of GDP (–ve = surplus) 1.5 –0.7 –0.2 –4.0 –0.3

Ann

ual g

row

th r

ate

(%)

UK general government expenditure as % of GDPUK general government expenditure as % of GDP

34

36

38

40

42

44

46

48

50

1970 1975 1980 1985 1990 1995 2000

Ann

ual g

row

th r

ate

(%)

UK general government expenditure as % of GDPUK general government expenditure as % of GDP

34

36

38

40

42

44

46

48

50

1970 1975 1980 1985 1990 1995 2000

Health 12.3%Education 10.9%

Other 7.3%

Defence 10.1%

Economic Affairs 7.7%

Public order 5.1%

HI

J

K

Social protection 36%

Social protection 39.0%

Health 14.2%Education 11.5 %

Other 14.2%

Defence 7.3%

Economic affairs 6.4%

Public order 5.6%H I

J

K

H General public services 4.4%I Housing, etc 3.6%J Recreation, etc 1.7%K Environment 0.9%

1991 1999

UK general government expenditure by function (%)UK general government expenditure by function (%)


Health 12.3%Education 10.9%

Other 7.3%

Defence 10.1%

Economic Affairs 7.7%

Public order 5.1%

HI

J

K

Social protection 36%

Social protection 39.0%

Health 14.2%Education 11.5 %

Other 14.2%

Defence 7.3%

Economic affairs 6.4%

Public order 5.6%H I

J

K


1991 1999

UK general government expenditure by function (%)UK general government expenditure by function (%)


General government deficits (–)or surpluses (+)

General government debt

Average1990–95

Average1996–2001

Average1990–95

Average1996–2001

Belgium –6.4 –1.8 128.9 117.3

France –4.3 –2.4 48.5 64.3

Ireland –2.6 +2.2 84.2 52.4

Italy –10.2 –2.7 115.4 115.5

Japan –0.8 –5.7 68.8 108.7

Netherlands –4.2 0.0 75.8 64.2

Sweden –6.1 +1.2 65.3 67.8

UK –5.3 –0.4 52.1 57.4

USA –4.5 +0.1 72.9 66.0

Euro area –5.1 –1.9 66.8 75.7

General government deficits/surplusesand debt as % of GDP

General government deficits (–)or surpluses (+)

General government debt

Average1990–95

Average1996–2001

Average1990–95

Average1996–2001

Belgium –6.4 –1.8 128.9 117.3

France –4.3 –2.4 48.5 64.3

Ireland –2.6 +2.2 84.2 52.4

Italy –10.2 –2.7 115.4 115.5

Japan –0.8 –5.7 68.8 108.7

Netherlands –4.2 0.0 75.8 64.2

Sweden –6.1 +1.2 65.3 67.8

UK –5.3 –0.4 52.1 57.4

USA –4.5 +0.1 72.9 66.0

Euro area –5.1 –1.9 66.8 75.7

General government deficits/surplusesand debt as % of GDP



fine tuning


financing a deficit

the PSNCR

the national debt and public-sector debt


fine tuning


financing a deficit

the PSNCR

the national debt and public-sector debt

Getting budget deficits down?Getting budget deficits down?

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD

P

France

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD

PGetting budget deficits down?Getting budget deficits down?

FranceGermany

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD


FranceGermany

Italy

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD


Spain

FranceGermany

Italy

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD


Spain

FranceGermany

Italy

Belgium

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD


Spain

FranceGermany

Italy

Netherlands

Belgium

-3

-1

1

3

5

7

9

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001Bud

get d

efic

its a

s a

% o

f GD


30

35

40

45

50

55

60

65

70

75

80

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

National Debt(as % of GDP)

National DebtNational Debt

30

35

40

45

50

55

60

65

70

75

80

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000



UK

30

35

40

45

50

55

60

65

70

75

80

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

USA



UK

30

35

40

45

50

55

60

65

70

75

80

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Euroarea

USA

UK




Public-sector deficits or surpluses and the government’s fiscal stance fiscal stance and the state of the economy the structural balance

Automatic fiscal stabilisers tax stabilisers benefits stabilisers



O

G, T

Y

Tax revenue

Gov. expenditure(incl. benefits)

Y1

DEFICIT

SURPLUS

National income and the size of the public-sector deficit or surplusNational income and the size of the public-sector deficit or surplus




Discretionary fiscal policy



Discretionary fiscal policy




Discretionary fiscal policy changing government expenditure



Discretionary fiscal policy changing government expenditure




Discretionary fiscal policy changing government expenditure changing taxes



Discretionary fiscal policy changing government expenditure changing taxes

A cut in taxes: (a) lump-sum taxesA cut in taxes: (a) lump-sum taxes

O

W, J

Y

W1

O

W, J

Y

W1

W2


O

W, J

Y

W1

W2

DT x mpcd


A cut in taxes: (b) cut in tax ratesA cut in taxes: (b) cut in tax rates

O

W, J

Y

W1

O

W, J

Y

W1

W2


O

W, J

Y

W1

W2

DT x mpcd



The Effectiveness of Fiscal Policy

The Effectiveness of Fiscal Policy

EFFECTIVENESS OF FISCAL POLICYEFFECTIVENESS OF FISCAL POLICY

Effectiveness of automatic stabilisers adverse supply-side effects

the problem of fiscal drag

Discretionary policy: problems of forecasting the magnitude of the effect effects on other injections and withdrawals

crowding out




crowding out

O

W, J

Y

(a) The goods market

W

J1

Y1

The monetary effects of fiscal policyThe monetary effects of fiscal policy

O O

W, JRate of interest

Y Money

(a) The goods market (b) The money market

W

J1

Y1

MS

L1

r1


O O


Y Money


W

J1

Y1

MS

L1

r1

Y2

J2

An expansionaryfiscal policy


O O


Y Money


W

J1

Y1

MS

L1

r1

Y2

J2


L2

r2

Effect on thedemand for money


O O


Y Money


W

J1

Y1

MS

L1

r1

Y2

J2


L2

Accommodatingincrease in themoney supply

MS2

r2






crowding out

size of the multiplier and accelerator effects




crowding out

size of the multiplier and accelerator effects


Discretionary fiscal policy: problems of timing and time lags

various time lags

policy may be destabilising


various time lags


Fiscal policy: stabilising or destabilising?Fiscal policy: stabilising or destabilising?

O

Rea

l nat

iona

l inc

ome

Time

1

2

3

4

1

2

3

4

Path (a): no intervention

O

Rea

l nat

iona

l inc

ome

Time

1

2

3

4

1

2

3

4


Path (b): policy stabilises


O

Rea

l nat

iona

l inc

ome

Time

1

2

3

4

1

2

3

4


Path (c): policy destabilisesPath (b): policy stabilises




various time lags


Side-effects of discretionary fiscal policy


various time lags





various time lags



Changing government expenditure versus changing taxes


various time lags



Changing government expenditure versus changing taxes


Varieties of Monetary Policy

Varieties of Monetary Policy

VARIETIES OF MONETARY POLICYVARIETIES OF MONETARY POLICY

The policy setting historical approaches to monetary policy

current approach to monetary policy

Control of money supply over medium and long term control of banks’ liquidity ratio

restricting size of PSNCR

Short-term monetary control: the alternatives

The policy setting historical approaches to monetary policy

current approach to monetary policy

Control of money supply over medium and long term control of banks’ liquidity ratio

restricting size of PSNCR

Short-term monetary control: the alternatives

The demand for and supply of moneyThe demand for and supply of money

O

Money

Ra

te o

f in

tere

st

MS

L

r1

Q1

O

Money

Ra

te o

f in

tere

st

L

r1

Q1

r2

Q2

MS'The demand for and supply of moneyThe demand for and supply of money

MS


Techniques to control money supply preliminary decisions:

statutory or prudent ratios?what to control: monetary base or broad

money? open-market operations funding variable minimum reserve ratios




Liabilities AssetsDeposits £100bn Reserve assets

Advances, etc.£10bn£90bn

Total £100bn Total £100bn

Effect of raising the minimum reserve ratiofrom 10% to 20%


Initial position: 10% reserve ratioInitial position: 10% reserve ratio









Initial position: 10% reserve ratioInitial position: 10% reserve ratio

New position: 20% reserve ratioNew position: 20% reserve ratio





Techniques to control interest rates




Techniques to control interest rates





Techniques to control interest rates statutory base rates




Techniques to control interest rates statutory base rates





Techniques to control interest rates statutory base rates operations in discount and repo markets





Bank of England operations in the bill andgilt repo markets to raise interest rates


O

(a) Bank of England sells more bills(a) Bank of England sells more bills

Ra

te o

f dis

coun

t

Bills

S1 by B. of E.

r1

D by banks

r2



O

Ra

te o

f dis

coun

t

Bills

S1 by B. of E.S2 by B. of E. D by banks

r1

(a) Bank of England sells more bills(a) Bank of England sells more bills

S by banks



O

(b) Bank of England buys fewer bills / gilts


Ra

te o

f dis

coun

t / g

ilt r

epo

ra

te

Bills and gilts

D1 by B. of E.

r1



O

Ra

te o

f dis

coun

t / g

ilt r

epo

ra

te

Bills and gilts

D1 by B. of E.

r1

D2 by B. of E.

r2

S by banks





statutory or prudent ratios?what to control: monetary base or broad money?

open-market operations funding variable minimum reserve ratios


Credit rationing


statutory or prudent ratios?what to control: monetary base or broad money?

open-market operations funding variable minimum reserve ratios


Credit rationing


Problems of Monetary Policy

Problems of Monetary Policy

PROBLEMS OF MONETARY POLICYPROBLEMS OF MONETARY POLICY

Medium and long-term control over the money supply: reducing PSNCR

automatic fiscal stabilisers

the desire to cut taxes

difficulty in cutting government expenditure

Medium and long-term control over the money supply: reducing PSNCR

automatic fiscal stabilisers

the desire to cut taxes

difficulty in cutting government expenditure


Practical difficulties in short-run control of the money supply problems with monetary base control

with statutory cash ratios

without statutory cash ratios

problems with controlling broad liquiditywith statutory reserve ratios

without statutory reserve ratios

the effect on interest rates

Practical difficulties in short-run control of the money supply problems with monetary base control

with statutory cash ratios

without statutory cash ratios

problems with controlling broad liquiditywith statutory reserve ratios

without statutory reserve ratios

the effect on interest rates

O

Money

Ra

te o

f in

tere

st

MS

L

r

L '

r1

The effect on interest rates of a change in demand for money: money supply kept at fixed level by the authorities

The effect on interest rates of a change in demand for money: money supply kept at fixed level by the authorities


Problems with credit rationing Goodhart's law bank resistance stifles competition distortionary effects on economy

Problems with controlling interest rates inelastic demand for loans


Problems with controlling interest rates inelastic demand for loans

O

Demand for loans

Q1Q2

Assume that the authoritieswant to reduce the

demand for money to Q2

r1

Loans

Rat

e of

inte

rest

An inelastic demand for loansAn inelastic demand for loans

r2

O

Demand for loans

r1

Q1Q2

A large rise in therate of interest (to r2)

will be necessary

Loans

Rat

e of

inte

rest

An inelastic demand for loansAn inelastic demand for loans



Problems with controlling interest rates inelastic demand for loans unstable demand for money


Problems with controlling interest rates inelastic demand for loans unstable demand for money



Problems with controlling interest rates inelastic demand for loans unstable demand for money possible conflict between domestic goals

and exchange-rate goals


Problems with controlling interest rates inelastic demand for loans unstable demand for money possible conflict between domestic goals

and exchange-rate goals


Using monetary policy

problems of using it to manage aggregate demand

using it to keep to a target

inflation

exchange rate

money supply

Using monetary policy

problems of using it to manage aggregate demand

using it to keep to a target

inflation

exchange rate

money supply


ISLM Analysis of Fiscal and Monetary

Policy

ISLM Analysis of Fiscal and Monetary

Policy

Equilibrium in both the goods and money marketsEquilibrium in both the goods and money markets

O

Ra

te o

f in

tere

st

National income

IS

re

Ye

LM

ISLM ANALYSIS OF FISCAL AND MONETARY POLICYISLM ANALYSIS OF FISCAL AND MONETARY POLICY

Fiscal policy and ISLM analysis

shifting the IS curve

effect on interest rates and national income




O

Ra

te o

f in

tere

st

National income

LM

IS

r1

Y1

ISLM analysis of fiscal and monetary policyISLM analysis of fiscal and monetary policy

O

Ra

te o

f in

tere

st

National income

IS1

r1

Y1

IS2

r2

Y2

Expansionaryfiscal policy

LM





Monetary policy and ISLM analysis

shifting the LM curve





Monetary policy and ISLM analysis

shifting the LM curve



O

Ra

te o

f in

tere

st

National income

LM1

IS

r1

Y1

LM2

r3

Y3

Expansionarymonetary policy


Fiscal policy and ISLM analysis shifting the IS curve effect on interest rates and national

income

Monetary policy and ISLM analysis shifting the LM curve effect on interest rates and national

income

Fiscal and monetary policy together

Fiscal policy and ISLM analysis shifting the IS curve effect on interest rates and national

income

Monetary policy and ISLM analysis shifting the LM curve effect on interest rates and national

income

Fiscal and monetary policy together


LM2LM1

O

Ra

te o

f in

tere

st

National income

IS1

r1

Y1

IS2

Y4

Expansionaryfiscal and

monetary policy


Analysis under Keynesian assumptions

effectiveness of fiscal policy




O

Ra

te o

f in

tere

st

National income

LM

IS1

Y1

IS2

Y2


Keynesian analysis of fiscal and monetary policyKeynesian analysis of fiscal and monetary policy



ineffectiveness of monetary policy





O

Ra

te o

f in

tere

st

National income

LM1

ISY1Y2


LM2

Keynesian analysis of fiscal and monetary policyKeynesian analysis of fiscal and monetary policy




Analysis under monetarist assumptions










ineffectiveness of fiscal policy







O

Ra

te o

f in

tere

st

National income

LM

IS1

Y1Y2


IS2

Monetarist analysis of fiscal and monetary policyMonetarist analysis of fiscal and monetary policy






effectiveness of monetary policy






effectiveness of monetary policy


O

Ra

te o

f in

tere

st

National income

LM1

IS

Y1 Y2


LM2

Monetarist analysis of fiscal and monetary policyMonetarist analysis of fiscal and monetary policy


Fiscal and Monetary Policy in the UK

Fiscal and Monetary Policy in the UK

Growth%

-10

-5

0

5

10

1920 1925 1930 1935 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000-10

-5

0

5

10

15

20

25

30

UK growth, unemployment and inflation: 1920-2002UK growth, unemployment and inflation: 1920-2002

Growth%

-10

-5

0

5

10

1920 1925 1930 1935 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000-10

-5

0

5

10

15

20

25

30


GrowthUnemployment

% %

-10

-5

0

5

10

1920 1925 1930 1935 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000-10

-5

0

5

10

15

20

25

30


GrowthUnemployment

Inflation

% %

-10

-5

0

5

10

1920 1925 1930 1935 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000-10

-5

0

5

10

15

20

25

30


Unemployment(% of labour

force)

Inflation(% increase in

RPI)

Growth(% increase in

real GDP)

1921–38 13.4 –1.5 2.1

1950–69 1.6 4.0 2.8

1970–99 7.6 8.0 2.0

UK Macroeconomic performance: 1921 – 99UK Macroeconomic performance: 1921 – 99


force)


RPI)


real GDP)

1921–38 13.4 –1.5 2.1

1950–69 1.6 4.0 2.8

1970–99 7.6 8.0 2.0



force)


RPI)


real GDP)

1921–38 13.4 –1.5 2.1

1950–69 1.6 4.0 2.8

1970–99 7.6 8.0 2.0


FISCAL AND MONETARY POLICY IN THE UKFISCAL AND MONETARY POLICY IN THE UK

Attitudes towards demand management

Keynesian demand management in the 1950s and 1960s stop–go policies monetarist criticisms

Demise of fine tuning in the 1970s the causes of stagflation demand management policies in the 1970s the rise of monetarism

Attitudes towards demand management

Keynesian demand management in the 1950s and 1960s stop–go policies monetarist criticisms

Demise of fine tuning in the 1970s the causes of stagflation demand management policies in the 1970s the rise of monetarism

Changein M4 (%)

(1)

PSNCR(£m)

(2)

Inflation(%)(3)

Interest rate:20-year bonds

(4)

Real interestrate

(5)1969 5.1 –527 5.4 9.1 3.71970 11.5 –219 6.3 9.2 2.91971 16.0 1 196 9.4 8.9 –0.51972 23.7 1 829 7.3 9.0 1.71973 22.3 4 121 9.1 10.7 1.61974 11.1 6 447 16.0 14.8 –1.21975 12.4 10 167 24.2 14.4 –9.81976 11.2 8 923 16.5 14.4 –2.11977 14.7 5 474 15.9 12.7 –3.21978 15.0 8 416 8.3 12.5 4.21979 14.1 12 502 13.4 13.0 –0.41980 17.2 11 432 18.0 13.8 –4.21981 20.9 10 573 11.9 14.7 2.81982 12.1 5 547 8.6 12.9 4.31983 12.7 11 070 4.6 10.8 6.21984 13.2 10 342 5.0 10.7 5.71985 13.0 7 625 6.1 10.6 4.51986 15.6 2 630 3.4 9.9 6.51987 16.7 –1 172 4.2 9.5 5.31988 17.3 –11 426 4.9 9.4 4.51989 18.0 –9 131 7.8 9.6 1.81990 11.8 –1 288 9.5 11.1 1.61991 5.8 7 003 5.9 9.9 4.01992 3.6 28 623 3.7 9.1 5.41993 4.6 43 168 1.6 7.9 6.31994 4.7 39 425 2.4 8.1 5.71995 9.9 35 446 3.5 8.3 4.81996 9.5 24 778 2.4 8.1 5.71997 11.9 11 851 3.1 7.1 4.01998 8.3 –6 395 3.4 5.5 2.11999 4.2 –1 781 1.6 4.7 3.12000 8.3 –37 316 2.9 4.7 1.82001 6.7 –2 665 1.8 4.8 2.0

Selected monetary indicators: 1969–2001Selected monetary indicators: 1969–2001

Monetarism in the early 1980s medium-term financial strategy the recession of the early 1980s assessment of the monetarist experiment return to discretion in mid 1980s

Targeting the exchange rate its advantages and disadvantages shadowing the German mark membership of the ERM (1990–2) exit from the ERM

Monetarism in the early 1980s medium-term financial strategy the recession of the early 1980s assessment of the monetarist experiment return to discretion in mid 1980s

Targeting the exchange rate its advantages and disadvantages shadowing the German mark membership of the ERM (1990–2) exit from the ERM


Return to domestic-orientated policies targeting inflation: 1993–7

Policies of the Labour government 1997 fiscal policy

the 'Golden Rule'Comparison with EU Stability and Growth Pact

monetary policyBank of England inflation targetECB targets

effectiveness of recent monetary and fiscal policies

Return to domestic-orientated policies targeting inflation: 1993–7

Policies of the Labour government 1997 fiscal policy

the 'Golden Rule'Comparison with EU Stability and Growth Pact

monetary policyBank of England inflation targetECB targets

effectiveness of recent monetary and fiscal policies



Rules versus Discretion

Rules versus Discretion

RULES VERSUS DISCRETIONRULES VERSUS DISCRETION

Case against discretion time lags

over-correction

government may ignore long-term consequences

Case for rules help to reduce inflationary expectations

create a stable environment for investment and economic growth

Case against discretion time lags

over-correction

government may ignore long-term consequences

Case for rules help to reduce inflationary expectations

create a stable environment for investment and economic growth


Case against rules can cause severe fluctuations in interest

rates and can cause greater instability

which rule to choose?

rules may conflict

rules may become unsuitable

Case for discretion fine tuning can be improved by better

forecasting and quicker-action

Case against rules can cause severe fluctuations in interest

rates and can cause greater instability

which rule to choose?

rules may conflict

rules may become unsuitable

Case for discretion fine tuning can be improved by better

forecasting and quicker-action


Inflation targeting use of inflation targets around the world

Inflation targeting use of inflation targets around the world

Source: The Use of Explicit Targets for Monetary Policy: Practical Experiencesof 91 economies in the 1990s, (Bank of England, August 1999)

Who sets explicit targets and monitoring ranges forthe exchange rate, money and inflation











Source: Bank of England


Inflation targeting use of inflation targets around the world weaknesses of money supply targets

Inflation targeting use of inflation targets around the world weaknesses of money supply targets


Inflation targeting use of inflation targets around the world weaknesses of money supply targets weaknesses of exchange rate targets

Inflation targeting use of inflation targets around the world weaknesses of money supply targets weaknesses of exchange rate targets


Inflation targeting use of inflation targets around the world weaknesses of money supply targets weaknesses of exchange rate targets relative strength of inflation targets




Issues with inflation targets


Issues with inflation targets



Issues with inflation targets choice of the target

what level?central point or ceiling?


Issues with inflation targets choice of the target

what level?central point or ceiling?


Issues with inflation targets (cont.) who sets the target?

changing the target

multiple targetsa Taylor rule for setting interest rates


changing the target


Y0O

National income

ADI1

Rat

e of

infla

tion

(P).

Ptarget

.

ADI curves based on different Taylor rulesADI curves based on different Taylor rules

a

Y1

Curve ADI1: based on Taylor rule givingrelatively high weight to stable inflation

P1

. b

ADI2

Y0O

National income

ADI1

Rat

e of

infla

tion

(P).

Ptarget

. a

Y2Y1

b c

Curve ADI1: based on Taylor rule givingrelatively high weight to stable inflation

Curve ADI2: based on Taylor rule giving relativelyhigh weight to stable real national income

P1

.

ADI curves based on different Taylor rulesADI curves based on different Taylor rules



changing the target


targeting inflation and the money supply


changing the target





changing the target



basing interest rates on forecasts of inflation


changing the target






changing the target




the problem of deflation


changing the target




the problem of deflation

Date post:	16-Jan-2016
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Fiscal and Monetary Policy. Fiscal and Monetary Policy The Nature of Fiscal Policy.

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