Impact of Oil Prices and Monetary Policy on Economy: A Case Study, Assignments of Economic policy

Download Impact of Oil Prices and Monetary Policy on Economy: A Case Study and more Assignments Economic policy in PDF only on Docsity! ECON411 PS4 Yihan Zhou 2270683 1. Increase in the oil prices will cause two effects. Firstly, it will negatively affect the consumer spending on the U.S. goods and services, which will cause the AE curve shift to the left. Since the real interest rate remains constant, the output level will decrease. In addition, the phillips curve will shift upwards, the output level will decrease, which means although the inflation is higher, the increase in inflation will be smaller than the increase in firm’s raw material cost. 2. A: shown in the picture B: From the Figure 12.21, in the interest rate graph, we can see the interest rate increase between 2019 and 2020, remain the same between 2020 and 2021, and then decrease between 2021 and 2022. Therefore, since the AE curve will always be unchanged, we can know the output level will decrease between 2019 and 2020, remain the same between 2020 and 2021, and then increase between 2021 and 2022. Therefore, the output path remains the same. For the path of inflation rate, we need to regard to the phillips curve, and the inflation rate is dependent on the expectation. From 2019 to 2020, since the expected inflation rate remains the same, the inflation rate will fall by the same amount as shown in Figure 12.21. However, from 2020 to 2021, since the new expected inflation in this question is higher than we normally assume, the inflation rate will still fall but in a less amount than shown in Figure 12.21 and the disinflation period will be longer than that of in the textbook. 3. When the bond traders expect an increase in the federal funds rate, it will increase longer- term interest rates, so that the asset prices such as stock prices will fall, and exchange rate will increase. In addition, higher interest rate reduces aggregate expenditure. However, in this question, the FOMC surprises them by keeping it constant, the longer- term rates will then fall gradually. The long-term interest rates will gradually decrease, and the asset prices such as stock prices will gradually increase, and the exchange rate will then decease. 4. A: When the riskiness of assets increases, the banks will face insolvency. In order to solve this problem, the bank need to increase the equity ratio to avoid bank insolvency. Bank will increase the capital and decrease the assets by making fewer loans. B: Economic boom is a period when actual output exceeds potential output, and an Economic recession is a period when actual output falls below potential output. In the economic boom, the economy is not worried about bank insolvency, so it doesn’t need to achieve a high equity ratio. The public is easy to get a bank loan. However, in the economic recession, when the riskiness of assets increases, in order to prevent the bank insolvency, the bank need to increase the equity ratio by decreasing the assets. Therefore, banks will make fewer loans. Thus, the public will be much harder to get a bank loan. 5. Following by the Taylor Rule, the central bank should make the ex-ante real interest rate at its neutral level. However, when the central bank believes the neutral rate is 1 percent, which is lower than the true neutral rate of 3 percent, the economy will unconsciously undergo a lower interest rate, which will cause the monetary policy more expansionary than it should be. Lower interest rate will cause a boom, increase the output level and inflation. The inflation will permanently be high by the Taylor formula, and the central bank cannot meet its inflation target. 6. (a): The S under TR-S might stand for a more stable real interest rate. From the TR-S formula, there will be a less obvious change on the interest rate than that from the Taylor rule in a short time period. However, because of the inflation target, the TR-S interest rate will gradually be close to the interest rate calculated by Taylor rule in the long run. (b): From my perspective, the central bank should follow the TR-S rule rather than the Taylor rule, since this interest rate change is more stable. When setting the interest rate, the central bank should consider the fluctuation on neutral real interest rate and output gap and then set the interest rate a bit smaller than the interest rate calculated, which will be achieved by using the TR-S rule. 7. (a): Since Ben Bernanke is a well-known economist who has a good reputation to solve the time-inconsistency problem. Therefore, people have good expectation towards the stock market and their future earnings after Ben Bernanke becoming the Fed chair. Therefore, the stock index jumped by more than 1 percent in a few minutes. In addition, this announcement is also an inflation-surprise decision, which will stimulate the output in the short-run, but no one has expected it before. (b): When inflation targeting begins, central banks publish more information about their policies, and the policy reduces the dangers of discretionary policy and anchors inflationary expectations. Therefore, the announcement will not be an inflation-surprise decision anymore, and the stock index will not be expected to change so large. Under the