Author Question: Consider two alternative worlds: (i) the world works according the real business cycle model, and ... (Read 83 times)

JGIBBSON · **on:** Jun 30, 2018

Consider two alternative worlds: (i) the world works according the real business cycle model, and the central bank acts to stabilize the price level; (ii) the world works according to the New Keynesian sticky price model, and the central bank acts to

make the output gap zero. Which is correct? A) We would prefer to live in world (ii).
B) We would prefer to live in world (i).
C) The data cannot tell us whether we are living in world (i) or world (ii).
D) in either world, the central bank is irrelevant.

Question 2

What are the main arguments for and against Fed independence?

What will be an ideal response?

mk6555 · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

A

Answer to Question 2

The main argument for Fed independence is that monetary policy, which affects inflation, interest rates, exchange rates, and economic growth, is too important and technical to be determined by politicians. Because of the frequency of elections, politicians with a desire to get reelected may be concerned with short-term benefits without regard for potential long-term costs. Also, independence decreases the likelihood of being influenced by political pressure prior to elections, such as politicians pressuring for increases in the money supply to increase GDP and employment, at the risk of increasing inflation in the long run.
The main argument against Fed independence is also the importance of monetary policy for the economy. Supporters claim that in a democracy, elected officials should make public policy. Also, placing the Fed under the control of elected officials could be beneficial by coordinating and integrating monetary and fiscal policies.