1. Proponents of inflation targeting argue that it would make central banks more _______ if they were committed to a long-run inflation target.

2. In_______, inflation targeting was adopted in 1992, and elected officials determine the precise inflation targets that the central bank must meet.

3. Economist_______ developed a rule for monetary policy that maintains a low rate of inflation but allows the Fed to adjust interest rates when output deviates from potential.

4. If the Federal Reserve is more credible, long-term interest rates will be more responsive to changes in short term rates. _______ (True/False)

5. Targeting the Price Level with Supply Shocks. Suppose the Fed has brought the inflation rate down to zero to stabilize the price level. An adverse supply shock (such as an increase in the world price of oil) now hits the economy.

a. Using the aggregate demand-and-supply model, show how targeting the price level would make the fall in output from the shock greater as compared to no policy at all. b. Some proponents of price-level or inflation targeting recommend that the Fed target core inflation, which is based on a price index that excludes supply shocks. What is their rationale?

6. What Rate for Inflation Targeting? An economist suggests that what matters for financial markets is a stable inflation rate, not a zero inflation rate. As long as inflation is stable, all individuals can take this into account in their actions.

a. What are the costs associated with a stable inflation rate of 2 percent?

b. Is it easier or more difficult to stabilize inflation at 2 percent rather than at zero?

7. The Fed on Autopilot. Some economists believe that the Federal Reserve should follow strict rules for the conduct of monetary policy. These rules would require the Fed to make adjustments to interest rates based on information that is fully available to the public, information such as the current unemployment rate and the current inflation rate. Essentially, they would put the Fed on autopilot and remove its discretion. What are the pros and cons of such an approach? Would it work in a financial crisis?

8. What Difference Would Focusing on Asset Prices Make? Suppose you believed the Fed should make its decisions by focusing partly on asset prices, such as stocks or prices of housing, and should have used monetary policy to offset both the stock market increase in the late 1990s and the housing price increases after 2002. How would your policy have affected interest rates and real output during the period in question? What would be the benefit of your policies?