week 4

• Raising interest rates may be ineffective in managing asset price bubbles, as it is unrealistic to expect the usual tools will be effective in abnormal conditions
• Types of asset price bubbles

  • Credit driven
  • Driven from 'irrational exuberance'
• Raising interest rates may be ineffective in managing asset price bubbles, as the market participants are expecting even higher rates of return
• Asset price bubbles

  Go against the CAPM, as the assumptions of the CAPM and Efficient Market Hypothesis don't hold
• Credit driven asset price bubbles

  • Housing price bubble within the US market
• Asset price bubbles are market specific, but monetary policy will impact overall prices, and so intervention may harm the overall economy
• Asset price bubble

  Sharp increases in asset prices that depart from fundamental values, which eventually burst
• Burst of a credit bubble


  May lead to a financial crisis
• Asset price bubbles are hard to define and measure, and cannot be modelled
• Dual mandates


  Attempt to achieve two equally important objectives at the same time
• Dual mandates


  Can conflict
• The USA's Federal Reserve follows a dual mandate monetary objective
• hierarchical mandates have a primary target which, once achieved, will then pursue other goals
• the Bank of England and ECB use a hierarchical mandate
• Central bank independence reduces the influence of the political business cycle in monetary policy
• Independent central banks are proven to deliver low inflation
• Goal independence

  The central bank can freely implement policy and freely adjust its policy tools to fulfil objectives
• Central bank independence


  Government doesnt control Monetary Policy
• The Bank of England does not have goal independence
• Central bank independence may not be supported because it is undemocratic
• The Fed, ECB, and Bank of England all have instrument independence
• The Fed has a high level of goal independence
• Central bank independence


  May become difficult to coordinate fiscal and monetary policy, especially when their goals and aims differ
• Central bank independence reduces the risk of the political business cycle
• Central bank independence


  Freedom of monetary policymakers from direct political or governmental influence
• inflation targeting involves framework to preserve price stability, and keep inflation within a desired range
• the inflation target is achieved through adjustments to the Monetary Policy Rate (MPR)
• the Monetary Policy Rate (MPR) is the Central Bank interest rate
• advanced countries tend to have lower inflation targets than developing countries
• inflation targeting involves a public announcement of a medium-term numerical target for inflation
• inflation targeting involves a commitment to price stability as the primary, long-term monetary policy goal
• inflation targeting involves an information-inclusive approach where many variables are used in making decisions
• inflation targeting involves [[Transparency]], using monetary policy reports and minutes
• inflation targeting involves accountability, where if the target is missed, the Central Bank must write a letter explaining why it was missed
• inflation targeting has resulted in lower inflation and lower inflation volatility
• advantages of inflation targeting is that it reduces the Time-inconsistency problem, increases [[Transparency]] and increases accountability
• inflation targeting improves Central Bank performance in the long-run
• a disadvantage of inflation targeting is that signalling is delayed; tools have delayed impacts, and future events that may prevent the targets being met
• a disadvantage of inflation targeting is that it limits the Central Banks' ability to respond to unforeseen circumstances, or meet other objectives
• a disadvantage of inflation targeting is that it results in potentially higher output fluctuations, and episodes of low economic growth