Macro Module 22 Homework

(The attached PDF file has better formatting.)

Price mis-perceptions model (Chapter 15)

Barro discusses rules vs discretion as central bank policy.

Part A: If money is neutral, should a central bank be guided by rules or discretion? That is, if monetary policy affects inflation but not real variables, how should the central bank operate?

Part B: If money is not neutral, should a central bank be guided by rules or discretion? That is, if monetary policy affects real variables, how should the central bank operate?

Barro’s discussion is more nuanced. The choice of rules vs discretion is not guided solely by the neutrality of money. But the two topics are related. Keynesian economists generally take one position; Friedman and his school take the other. This homework assignment tests if you understand the basic concepts in this chapter; a one paragraph answer is sufficient.

Well here goes nothing:

Part A: If money is neutral, then discretionary policy is better as it allows the FED to "shock" the system to get a short term boost in GDP and Labor output. 

Part B: If money is not neutral then rules is the way to go as you will have greater transparency and are more likely to attract foreign investement and encourge GDP to grow for the right reasons (increasing the technology).  When money is not neutral, shocks to the system have longer term effects which are "real" as opposed to "nominal".

Any thoughts?

I think it is just the opposite. Money neutrality means changes in money supply have no affect on real variables so the shock just increases inflation with no real benefit.

[NEAS: Correct]