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Chapter 21 - Output, inflation, and monetary policy. The objective of this chapter is to understand fluctuations in inflation and real output and how central banks use conventional interest-rate policy to stabilize them. We will develop a macroeconomic model of fluctuations in the business cycle in which monetary policy plays a central role. | Chapter Twenty-One 21- Introduction An important part of economic analysis is speculation about the impact of the new data on monetary policy. The FOMC in the U.S. and the Governing Council in the Euro area always tie their policy actions to current and expected future economic conditions. Traders are trying to out-guess each other to make a profit by betting on what the next interest rate move will be. The rest of us are just hoping the central bank will succeed in keeping inflation low and real growth high. 21- Introduction The objective of this chapter is to understand fluctuations in inflation and real output and how central banks use conventional interest-rate policy to stabilize them. We will develop a macroeconomic model of fluctuations in the business cycle in which monetary policy plays a central role. 21- Introduction We will see that short-run movements in inflation and output can arise from two sources: Shifts in the quantity of aggregate output . | Chapter Twenty-One 21- Introduction An important part of economic analysis is speculation about the impact of the new data on monetary policy. The FOMC in the U.S. and the Governing Council in the Euro area always tie their policy actions to current and expected future economic conditions. Traders are trying to out-guess each other to make a profit by betting on what the next interest rate move will be. The rest of us are just hoping the central bank will succeed in keeping inflation low and real growth high. 21- Introduction The objective of this chapter is to understand fluctuations in inflation and real output and how central banks use conventional interest-rate policy to stabilize them. We will develop a macroeconomic model of fluctuations in the business cycle in which monetary policy plays a central role. 21- Introduction We will see that short-run movements in inflation and output can arise from two sources: Shifts in the quantity of aggregate output demanded, or Shifts in the quantity of aggregate output supplied. We will develop our macroeconomic model in three steps: A description of long-run equilibrium, The derivation of the dynamic aggregate demand curve, and An introduction of short-run and long-run aggregate supply. 21- Introduction We will see how modern central banks can use their policy tools to stabilize short-run fluctuations in output and inflation. Our ultimate objective is to understand how modern central bankers set interest rates. When policymakers change the target interest rate, what are they reacting to and what is the impact on the economy? 21- Output and Inflation in the Long Run The best way to understand fluctuations in the business cycle is as deviations from some benchmark or long-run equilibrium level. What would the levels of inflation and output be if nothing unexpected happened for a long time? In the long run, current output equals potential output and the inflation rate equals the level
