the economics of money, banking, and financial markets

(Sean Pound) #1
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  1. What are the advantages of structural model evidence if the structure is correct?
    Answer:
    a. Because we can evaluate each transmission mechanism separately to see whether it is
    plausible, we can gather more evidence on whether monetary policy has an important effect on
    economic activity.
    b. Knowing how changes in monetary policy affect economic activity may help us predict the
    effect of changes in M on Y more accurately.
    c. By knowing how the economy operates, we may be able to predict how institutional changes
    in the economy might affect the link between changes in M and Y.
    Diff: 3 Type: SA Page Ref: 27.1A- 2
    Skill: Recall
    Objective List: Appendix: Evaluating Empirical Evidence




  2. What are the advantages of reduced-form evidence?
    Answer: The main advantage of reduced-form evidence over structural model evidence is that
    no restrictions are imposed on the way monetary policy affects the economy. If we are not sure
    that we know what all the monetary transmission mechanisms are, we may be more likely to spot
    the full effect of changes in M on Y by looking at whether movements in Y correlate highly with
    movements in M.
    Diff: 1 Type: SA Page Ref: 27.1A- 3
    Skill: Recall
    Objective List: Appendix: Evaluating Empirical Evidence




  3. What is reverse causation and how does it relate to reduced-form evidence on monetary
    policy transmission?
    Answer: A basic principle applicable to all scientific disciplines, including economics, states
    that correlation does not necessarily imply causation. The situation where after finding
    correlation between two variables say M and Y, we conclude erroneously that one causes the
    other is called reverse causation. The fact that the movement of one variable is linked to another
    doesn't necessarily mean that one variable causes the other. The reverse causation problem may
    be present when examining the link between changes in money and aggregate output or
    spending. If most of the correlation between M and Y occurs because of the Bank's interest-rate
    target, controlling the money supply will not help control aggregate output because it is actually
    changes in Y that are causing changes in M rather than the other way around.
    Diff: 3 Type: SA Page Ref: 27.1A- 3
    Skill: Recall
    Objective List: Appendix: Evaluating Empirical Evidence



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