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A simple problem – let’s say the central bank has a 2% inflation ceiling. Ergo, if it records inflation expectations as over 2%, it will take action to lower those expectations, usually raising interest rates as a way of draining the money supply, which also has the effect of decreasing total economic activity. Additionally, everyone knows this, so when some activities or events occur that would ceteris paribus increase inflation expectations markets presume the central bank will act to quash inflation and therefore adjust their overall expectations of economic activity. This will probably manifest itself as a reluctance to invest.

Let’s say unemployment is 10%, inflation is 1%, and real GDP growth is 1%. Let’s further say that the central bank is willing to tolerate an unlimited amount of RGDP growth but refuses to budget on its inflation ceiling. Let’s further say that any activation of idle labor will necessitate some inflation due to short-to-medium-run supply inelasticities. And let’s say everyone knows all of this.

Let’s say some large positive exogenous shock causes a boom in labor demand in some sector or another. This model would predict a largely zero-sum net gain in employment or economic growth, as the increase in activity in that sector will be offset by a decline elsewhere. The only net increase would be that commensurate with accommodating short-to-medium run supply inelasticities – that is, there can be some net gain every period, but only enough that it doesn’t push up prices very much.

Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.

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