Chapter 19 Money Demand [cont.]
Further Developments in the Keynesian Approach
- Why Transactions demand depends upon i (Baumol)
- Tobin's Uncertainty Theory
- Friedman’s Modern Quantity Theory of Money
Chapter 20 The IS-LM Model
The IS curveThe LM Curve
- Investment and the interest rate
- Net exports and the interest rate
- Derive the IS curve from 45 degree line diagram
- Shifts in the IS curve
- Slope of IS curve
- Derive LM curve from money demand - money supply diagram
- Shifts in the LM curve
- Slope of the LM curve
- The liquidity trap
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The Fed must adopt an inflation target, by Frederic Mishkin, Commentary, Financial Times: Ben Bernanke, the Federal Reserve chairman, discussed his institution’s inflation mandate in a recent speech, leading to speculation a numerical inflation target is under consideration inside America’s central bank. And if there ever was a time to establish such a transparent and credible commitment to a specific target, it is now.
The Fed has a dual mandate, to achieve price stability and maximum sustainable employment. But at the moment it is missing both objectives. ... This combination of economic slack and low inflation raises the possibility that inflation expectations will drift downwards.
Meanwhile, to stimulate the economy, the Fed has signaled that it is likely to restart its policy of quantitative easing... This signal has already led to concerns ... that the Fed may be too soft on inflation in the future, which could see inflation expectations rise.
By establishing an inflation objective ... the Fed can guard against both of these problems. Providing a firm anchor for long-run inflation expectations would make the threat of deflation less likely. But a firm anchor would also ... help ensure that any new moves to quantitative easing would not be misinterpreted as signaling a shift in the central bank’s long-run inflation goal, making an upward surge in inflation expectations less likely too.
The Fed can establish a strong nominal anchor through two straightforward steps. First, the federal open market committee could come to a consensus on the specific numerical value that Mr Bernanke referred to as the “mandate-consistent inflation rate” in his recent speech..., about 2 per cent, or a bit below. Second, the FOMC should announce that this rate would only be modified for sound economic reasons...
Some commentators have worried that establishing an inflation objective will soon lead to an overemphasis on controlling inflation, and not enough concern about stabilizing real economic activity. Agreeing on a mandate-consistent rate is, however, consistent with the Fed’s dual mandate. Indeed the use of the term “mandate consistent” indicates that it should not be misinterpreted as a commitment to control inflation within too tight a range over too short a time horizon. Also, by allowing the rate to be adjusted if sound economic reasoning supports it, the Fed would not be locked in to an inappropriate goal.
A final concern is that these two steps would not provide a sufficient degree of commitment to the target itself. But by stating its intention not to modify the rate without a clear technical rationale, the FOMC would provide a firm nominal anchor ... for long-run inflation expectations.
By adopting an explicit numerical inflation objective at this juncture along the lines I have suggested, the Fed would improve economic outcomes by anchoring inflation expectations more firmly while allowing sufficient flexibility to ensure ... the goal of maximum sustainable employment as well. The Fed and its chairman should move quickly to introduce one.
