What you have said would be correct if the situation you are describing was what the question stated. When you say “they don’t think inflation is a problem for the next few months, that’s why they lowered their target inflation rate”…you are confusing the issue here. There is a fundamental difference between shifting the supply of money to attemp to obtain a target inflation rate, and shifting policy to establish a new target. There is a difference between the public’s expectation of inflation, the FED’s expectation of inflation, the actual inflation rate, and the ideal rate the the FED is targeting. Economic conditions do not always permit estimated or actual inflation to be at its targeted rate. You are assuming estimated and targeted are one in the same, but this is not the case. Think of it like this: Assume (as always in steady state analysis, but really a bit unlikely) that we start in equilibrium…inflation is at target, output gap is zero, unemployment at perceived natural rate, etc…Now…due to some shift in policy (political pressures to reduce inflation further, academic studies showing inflation is more productive at lower level, or some other reason), central bank decides it will lower target inflation rate. Simply reducing target doesn’t do much, so action must be taken to obtain it. There are two main methods of doing this: 1) Raise rates, introduce recessionary gap, send signal to public that inflation will permanently be targeted at a lower rate. As rate is slowly acheived, negative output gap begins to close, unemployment slowly retreats to a new natural rate, and we are in a new steady state. 2) They get lucky as hell and experience a very timely negative permanent inflation shock. This is a bit unlikely to happen. Either way, policy has shifted such that a new lower target has been established, and hence expectations going forward are that, while we will see fluctuations around this target, they will be at a lower level nonetheless.
This thread needs more Taylor Rule http://en.wikipedia.org/wiki/Taylor_rule and yes, I am sticking with my above answer. I think there is either a typo or a problem with the above question / answer.
Wyantjs, relax, it’s a forum for discussion, not for you to swear at everyone and tell them they are stupid. Look at the Taylor rule.
lcampbell Wrote: ------------------------------------------------------- > Wyantjs, relax, it’s a forum for discussion, not > for you to swear at everyone and tell them they > are stupid. Look at the Taylor rule. Lick my nuts buddy. The Taylor rule has nothing to do with this. Taylor’s rule is an interest rate rule, and uses inflation target as an exogenous variable.
Haha, okay okay. I’m withdrawing from this discussion anyway. Good luck to everyone else battling it out.
Auro, I would check with the book’s publisher for errata. B is the answer, by definition. The question asks what will happen to the inflation rate if the central bank LOWERS its target inflation rate (not federal funds rate). Ask yourself: how does a central bank reduce inflation?
This thread has provided some much needed comic relief tonight. I can understand it though, people’s brains are full and something so simple becomes to extremely complex. This is way over analyzed. It’s B.
that question sucks. it’s the type we’ll see on the exam, read two or three times, mull some situations…2 minutes will be gone and we’ll see be trying to deduce between b & c. econ questions can seem so simple, but very frustrating
A
ha i havnt even started reading for the Dec exam, but i am sure the answer is B. fortunately some economics is common snse and this is an example fo such
All of this confusion is because you would DECREASE the “targeted inflation rate” by INCREASING the FFR through the Taylor rule. Dumb question, really.
“Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or “target,” inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools”. (Quote) As I understand, “target inflation rate” is something that is quite *stable* and it makes no sense while the *actual inflation* is high and the Fed decrease its *target rate*.
The problem here is a TYPO. Auro, you typed the question wrong. That question ID in Qbank is typed as follows: “If a country’s economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country’s” Therefore everyone can calm down and agree that inflation will increase
Thanks for clearing things up, spurries. I was starting to go crazy with all these Taylor rule stuff. Good discussion, by the way.
I am willing to bet C… Herez my .02 unsustainable growth – Real GDP surpassed potential GDP …therefore inflation is already high Central Bank lowers target inflation rate: Therefore, has to use tools to decrease loanable funds by increasing FFR/Interbank lending rate So using AD-AS model, price spirals up due to AD right shift and AS left shift. Using Phillips Curve model, the movement along PC as unemployment rate decreases (growing economy), moves expected inflation leftward – increases. Finally, using Business Cycle model, AD shifts right more than LAS shifts right moving the price level upward. One of the cases in PC models, is that when exp infl = act infl, which is not obvious here, a decrease in exp infl will shift the SRPC downward decreasing the inflation rate. So all theories point to the same – C Coming to other responses, targeting lower inflation rate is meant to slow the economy therefore, cannot say Economy WILL increase. So A out. In case of B, Phillips Curve suggests contrary in a growing economy. Ultimately, though CB targets inflation downward, the unsustainable growth of the economy is likely to obey PC suggesting that expected inflation rate shoots up. comment…
Thanks for the reword, I stand corrected. Ov25 you basically summed everything up nicely, I came to similar conclusions right after I reconsidered the fundamentals of the question (worded the right way). I didn’t realize how much context came into play until this review month. One word can really throw you off.