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Monetary policy essay plans (Macroeconomics FHS) £6.95
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Monetary policy essay plans (Macroeconomics FHS)
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Structured essay plans of past exam Monetary policy essay questions. Prepared and used by a first class E&M student to revise for Section B of the Macroeconomics FHS paper.

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  • June 27, 2024
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  • 2023/2024
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[2019] Suppose that a new technology delivers an immediate and permanent improvement in
productivity that is observed by both the central bank and private sector agents. Discuss how an
inflation-targeting central bank should adjust monetary policy in response to the productivity change.
What factors determine the magnitude of the monetary policy response?

 Introduction:
o Permanent productivity improvements: MPL shifts up, so PS shifts up since PS is a
markup over ED = MPL due to imperfect competition in labour demand allowing lower
real wages

Setup and initial shock t=0:
 Assume one-period interest rate to output
transmission lag in IS curve (
)
 Assume AEPC ( )
T
 Economy starts at A (π= π , y=ye)
 MPL shifts up to MPL', so PS shifts up to PS'
 VPC shift right to VPC' with new y e'.
 PC and MR immediately shift right to intersect VPC
at new equilibrium Z
 At t = 0, economy still at old ye since CB cannot
influence output today. Inflation below target (π 0)
at new PC.
T=1 onwards
 In t=0, CB anticipates PC to shift down due to AE (π e
= π0), so targets C and cuts rates below new lower r s
to hit MR line, creating positive output gap.
 At t=1, economy at C (positive output gap, higher
inflation π1 > π0 but still below πT)
 Rise in inflation since WS>PS and price setters have
last mover advantage. Wage setters ask for high
nominal wages, firms agree, but set prices even
higher to move economy to PS curve
 Future periods, PC slowly shifts up due to AE and
CB slowly raises rates to new rs' (lower than initial
rs) to hit new ye'. C >> Z along MR line.
 Flatter slope of IS curve (-1/a), higher a, less change in r needed to shift y. Smaller monetary
response needed.
o IS curve:
o higher a: more loans/ mortgages in economy on variable rather than fixed rates, rates
affect real economy more easily
 Gentler MR curve, higher β (more inflation aversion in CB loss function, so allow more y volatility
to reduce π volatility), greater y1 at point C, larger monetary response needed.

o MR solves:

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