econnomices exercises

Monetary Policy (EC470) Homework 4

Giorgi Nikolaishvili

August 9, 2021

Exercise 1 (Policies for Economic Stability)

Part (a)

Suppose the neutral real interest rate is 3% in country A and 1% in country B. (i) What might explain this difference? (Hint: Think of the loanable funds theory and how it can tie in with the AE schedule. Check out the appendix at the end of Ch. 12 of the textbook if you have trouble making the connection.) (ii) If the central banks of the two countries choose the same inflation target, which country is at greater risk of a liquidity trap? Explain. (iii) Should the two countries choose the same inflation target? Explain.

Part (b)

Consider an asymmetric lean-against-the-wind policy by which policymakers lower the interest rate below the neutral level when a recession occurs but do not raise it in a boom. (i) What are the pros of this strategy? (ii) What are the cons of this strategy? (Hint: Refer to the AE-PC model.)

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