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Economists have no final consensus on whether a central bank should be required to focus only on inflation or should have greater discretion. For those who subscribe to the inflation targeting philosophy, the fear is that politicians who are worried about slow economic growth and unemployment will constantly pressure the central bank to conduct a loose monetary policy—even if the economy is already producing at potential GDP    . In some countries, the central bank may lack the political power to resist such pressures, with the result of higher inflation, but no long-term reduction in unemployment. The U.S. Federal Reserve has a tradition of independence, but central banks in other countries may be under greater political pressure. For all of these reasons—long and variable lags, excess reserves, unstable velocity, and controversy over economic goals—monetary policy in the real world is often difficult. The basic message remains, however, that central banks can affect aggregate demand through the conduct of monetary policy and in that way influence macroeconomic outcomes.

Asset bubbles and leverage cycles

One long-standing concern about having the central bank focus on inflation and unemployment is that it may be overlooking certain other economic problems that are coming in the future. For example, from 1994 to 2000 during what was known as the “dot-com” boom, the U.S. stock market, which is measured by the Dow Jones Industrial Index (which includes 30 very large companies from across the U.S. economy), nearly tripled in value. The Nasdaq index, which includes many smaller technology companies, increased in value by a multiple of five from 1994 to 2000. These rates of increase were clearly not sustainable. Indeed, stock values as measured by the Dow Jones were almost 20% lower in 2009 than they had been in 2000. Stock values in the Nasdaq index were 50% lower in 2009 than they had been in 2000. The drop-off in stock market values contributed to the recession of 2001 and the higher unemployment that followed.

A similar story can be told about housing prices in the mid-2000s. During the 1970s, 1980s, and 1990s, housing prices increased at about 6% per year on average. During what came to be known as the “housing bubble” from 2003 to 2005, housing prices increased at almost double this annual rate. These rates of increase were clearly not sustainable. When the price of housing fell in 2007 and 2008, many banks and households found that their assets were worth less than they expected, which contributed to the recession that started in 2007.

At a broader level, some economists worry about a leverage cycle , where “leverage” is a term used by financial economists to mean “borrowing.” When economic times are good, banks and the financial sector are eager to lend, and people and firms are eager to borrow. Remember that the amount of money and credit in an economy is determined by a money multiplier —a process of loans being made, money being deposited, and more loans being made. In good economic times, this surge of lending exaggerates the episode of economic growth. It can even be part of what lead prices of certain assets—like stock prices or housing prices—to rise at unsustainably high annual rates. At some point, when economic times turn bad, banks and the financial sector become much less willing to lend, and credit becomes expensive or unavailable to many potential borrowers. The sharp reduction in credit, perhaps combined with the deflating prices of a dot-com stock price bubble or a housing bubble, makes the economic downturn worse than it would otherwise be.

Questions & Answers

what is labor
Grace Reply
labor is any physical or mental effort that helps in the production of goods and services
Kwabena
what is profit maximizing level of out put for above hypothetical firm TC = Q3 - 21Q2 + 600 + 1800 P = 600 MC = 3Q2 - 42Q + 600
Sosna Reply
consider two goods X and Y. When the price of Y changes from 10 to 20. The quantity demanded of X changes from 40 to 35. Calculate cross elasticity of demand for X.
Sosna
sorry it the mistake answer it is question
Sosna
consider two goods X and Y. When the price of Y changes from 10 to 20. The quantity demanded of X changes from 40 to 35. Calculate cross elasticity of demand for X.
Sosna
The formula for calculation income elasticity of demand is the percent change in quantity demanded divided by the percent change in income.
Sosna
what is labor productivity
Lizzy Reply
if the demand function is q=25-4p+p² 1.find elasticity of demand at the point p=5?
Puja Reply
what are some of the difference between monopoly and perfect competition market
Obeng Reply
n a perfectly competitive market, price equals marginal cost and firms earn an economic profit of zero. In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit. Perfect competition produces an equilibrium in which the price and quantity of a good is economic
Naima
what are some characteristics of monopoly market
Obeng Reply
explicit cost is seen as a total experiences in the business or the salary (wages) that a firm pay to employee.
Idagu Reply
what is price elasticity
Fosua
...
krishna
it is the degree of responsiveness to a percentage change in the price of the commodity
Obeng
economics is known to be the field
John Reply
what is monopoly
Peter Reply
what is taxation
Peter
why do monopoly make excess profit in both long run and short run
Adeola Reply
because monopoly have no competitor on the market and they are price makers,therefore,they can easily increase the princes and produce small quantity of goods but still consumers will still buy....
Kennedy
how to identify a perfect market graph
Adeola Reply
what is the investment
jimmy
investment is a money u used to the business
Mohamed
investment is the purchase of good that are not consumed today but are used in the future to create wealth.
Amina
investment is the good that are not consumed
Fosua
What is supply
Fosua
 Supply represents how much the market can offer.
Yusif
it is the quantity of commodity producers produces at the market
Obeng
what is the effect of scarce resources on producers
Phindu Reply
explain how government taxes and government producer subsidies affect supply
Chanda
what is economic
Charles Reply
what are the type of economic
Charles
macroeconomics,microeconomics,positive economics and negative economics
Gladys
what are the factors of production
Gladys
process of production
Mutia
Basically factors of production are four (4) namely: 1. Entrepreneur 2. Capital 3. Labour and; 4. Land but there has been a new argument to include an addition one to the the numbers to 5 which is "Technology"
Elisha
what is land as a factor of production
Gladys
what is Economic
Abu
economics is how individuals bussiness and governments make the best decisions to get what they want and how these choices interact in the market
Nandisha
Economics as a social science, which studies human behaviour as a relationship between ends and scarce means, which have alternative uses.
Yhaar
Economics is a science which study human behaviour as a relationship between ends and scarce means
John
Economics is a social sciences which studies human behavior as a relationship between ends and scarce mean, which have alternative uses.....
Pintu
how will a country's population be equal to it's labour force
Hope Reply
what is the meaning of ppf
Obeng Reply
Production Possibility Frontier
Igbekele

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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