ONLY ANSWER PART C! Both advanced and developing countries have experienced a de
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Question
ONLY ANSWER PART C!
Both advanced and developing countries have experienced a decrease in inflation since the 1980s (see Table 3-3 in the text). This question considers how the choice of policy regime has influenced such global disinflation. Use the monetary model to answer this question. The Swiss Central Bank currently targets its money growth rate to achieve policy objectives. Suppose Switzerland has output growth of 3% and money growth of 8% each year. What is Switzerland's inflation rate in this case? Describe how the Swiss Central Bank could achieve and inflation of 2% in the long run through the use of a nominal anchor. Like the Federal Reserve, the Reserve Bank of New Zealand uses an interest rate target. Suppose the Reserve Bank of New Zealand maintains a 6% interest rate target and the world real interest rate is 1.5% (New Zealand is a small, open economy and thus cannot influence in the world real interest rate. what is the New Zealand inflation rate in the long-run? In 1997 New Zealand adopted a policy agreement that required the bank to maintain an inflation rate no greater that 2.5%. What interest rate targets would achieve this objective? Assuming the demand for liquidity and real national income are fixed, what should the growth rate in the nominal money supply be to achieve this goal?Explanation / Answer
Ans: a) The inflation rate in thsi case will be equal to money growth rate - output growth rate = 8%-3% = 5%
b) In the long run, the Central banks can achieve inflation of 2% by using nominal anchors. One of the palyers in such a case could be to peg the value of the domestic currency to that of of a low inflation country. Such a provision would have a few highlights that the domestic monetary policy would largely be affected by that of the other country to which it is pegged on grounds of low inflation. Another alternative in this case would be to control inflation by targeting money supply if money growth is related to inflation in a stable way.
c) Given the above information, using the Fisher Effect , the inflation rate in NZ should be equal to roi (NZ)- world roi= 6%-1.5% = 4.5%
In order to maintain interest rates no greater than 4%, NZ should set its interest rate = world roi + its own targeted inflation rate = 1.5% + 2.5% = 4%
This suggests that the targeted interest rates should be 4% or any lower which would mean an inflation rate of less than or equal to 2.5%
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