Money, Banking, and International Finance Nominal GDP: If an economy produces more goods and services, then both real and
nominal GDP increase. If inflation causes higher prices, subsequently, the greater prices
increase nominal GDP, but have no effect on real GDP. Some economists believe the Fed
cannot influence real GDP, but it can affect the inflation rate, which in turn affects the
nominal GDP. If the Fed selected nominal GDP as an intermediate target, then the Fed
would be focusing on price stability indirectly. Yield Curve: Some economists suggested the Fed use the yield curve as an intermediate
target. Although the Fed examines the yield curve, the yield curve's shape depends on
investors' expectations of inflation and real interest rates. Commodity prices: Some economists suggested the Fed focus on commodity prices.
However, commodity prices do not accurately predict inflation well. U.S. dollar exchange rate: Exchange rates can predict inflation and real GDP growth rate.
Nevertheless, the exchange rate could respond to changes in the interest rate between
countries. International investors invest in countries with high real interest rates.Monetary policy can become ineffective in some cases. For instance, Japan entered a
perpetual recession, starting in the 1990s. Businesses and consumers became very pessimistic;
when the Japanese central bank lowered the interest rate, but it had no impact on the economy.
After the housing bubble popped in 2007 in the United States, the Federal Reserve has pursued
expansionary monetary policy. However, the U.S. economy is faltering and sputtering still in
2013 , even with a discount rate close to zero!
Japanese and U.S. struggling economies lead to the idea of cyclical asymmetry, which is the
contractionary monetary policy is always effective, while expansionary monetary can be
impotent at times. Thus, the low interest rates do not change consumers' and investors' behavior,
but high interest rates do. Consequently, some experts believe a central bank should concentrate
only on one target - inflation. Thus, a central bank should not focus on the economy but
maintain low inflation. Central banks in Canada, Eurozone, New Zealand, Sweden, and United
Kingdom maintain low inflation rates, causing appreciating currencies. If an economy has over a
10% inflation rate, then most likely the central bank is increasing the money supply too quickly
while the central bank pursues other targets not related to price stability. Finally, a country with
an independent central bank from government could experience low inflation rates because the
central bank can focus on price stability and not help its government finance its budget.
Key Terms
expansionary monetary policy
contractionary monetary policy
open-market operation
Federal Open Market Committee
general directive
Term Auction Facility Program
announcement effect
reserve requirement
monetary policy goal
price stability