MONETARY ECONOMIC _ TASK III

A Monetary Rules Versus Discretion in Monetary Policy

BY : NURUL FADILAH ( 021100013 ) RIA AMALIA ( 021100032 )

THE SUMMARY
POINT 1 Time Lags in Monetary Policy and the case for rules inflation is one of the limitations of the signal is lags. the reverse of monetary aggregates, inflation is not easily controlled by the monetary authorities. Further, because of interval of time (lags) are length of the effects of monetary policy, inflation results in the show after long intervals of time. thus the inflation target can immediately send a signal to the public and market about the direction of monetary policy. nevertheless, we have seen that the signals given by monetary aggregates may not be very strong. thus, not at all clear that monetary targeting is more superior than targeting POINT 2 Discretion in Monetary Policy and Inflation 1. Monetary tagetting Advantages: the achievement of the target signal can be determined Disadvantages: does not depend on the relationship between money and inflation 2. Inflation targeting Advantages: The convenience and clear the target Does not depend on the relationship of money and inflation are stable Increased accountability of central banks Reduce impact of r inflationary shock

Disadvantage Signal is delayed about achieving the target Using a rigid rules of (although not in reality) Output fluctuations more bigger if only focuses on inflation (although not in Reality). POINT 3 Making monetary policy rules credible Recent economic research suggests that monetary policy will be more effective if it is both transparent and credible. A transparent monetary policy is one in which the central bank clearly states its commitment to some goalin this case achieving price stabilityand how it intends to get there. Credibility is attained when the central bank's actions are consistent with reaching this goal. For the Federal Reserve, the goal is a sustained, low inflation rate. But a low inflation rate does not necessarily guarantee a credible monetary policy, for straightforward reasons: If financial markets are unsure of the Federal Reserve's commitment to keeping inflation in check, then the Fed's credibility with them will be suspect. Many economists believe that one way the Fed, or any central bank, can enhance its credibility is with a transparent policy rule that is deliberately designed to achieve long-term price stability.
POINT 4 Central Bank Independent: International Evidence Central bank independence refers to the freedom of monetary policymakers from direct political or governmental influence in the conduct of policy. When the central banks weight on inflation exceeds that of the elected government, the central bank is described as a Rogoffconservative central bank (Rogoff 1985). Rogoffs formulation reflects both a form of goal independence the central banks goals differ from those of the government an instrument independence the central bank is assumed free to set policy to achieve its own objectives. Because the central bank cares more about achieving its inflation goal, the marginal cost of inflation is higher for the central bank than it would be for the government. As a consequence, equilibrium inflation is lower. The 1990s saw many countries, both develop and developing, adopt reforms that increased central bank independence. This trend was strongly influenced by empirical analysis of the relationship between central bank independence and macroeconomic 5performance. Among the developed economies, central bank independence was found to be negatively correlated with average inflation. The estimated effect of independence on inflation was statistically and economically significant. Based on data from the high inflation years of the 1970s, for example, moving from the status of the Bank of England prior to the 1997 reforms that increased its independence to the level of independence then enjoyed by the Bundesbank would be associated with a drop in annual average inflation of four percentage points.