Discretionary Monetary Policy Is The Monetary Authorities Based On The Current Economic Crisis

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Discretionary monetary policy is the monetary authorities based on the current economic situations and relevant macroeconomic objectives to achieve economic targets through appropriate tools (such as open market operations and the discount rate etc.) to operate expansion or tightening monetary policies(Barro, 1990). This essay will first introduce the optimal discretionary monetary policy and then investigate the role of supply shock in that policy. Afterwards, analyze the implication of the supply shock in discretionary model and how it helps the European Central Bank’s (ECB’s) responds to 2007-2008 financial crisis. And finally conclude the relationship between the implication of discretionary theory with shock and the real responds to…show more content…
That is the output is lower than the natural rate of output, so CB plays a role to push up output level to the efficient level. Another explanation is that the candidates of political election make pressure to expand the economy in order to improve the possibility of success. This loss function includes the variance of output and thus CB has the role of stabilizing the economy. The aggregate supply is simply defined by Lucas island model in this essay: . is the private agency expectation for inflation, is the aggregate supply shock with mean 0 and constant variance . Then rearrange supply function, we obtain the short-run Phillips Curve (PC) . This illustrates in Figure 1. The order of discretionary policy model is significant. First, the private agency determines nominal wage through their inflation expectation. Then the policy makers determine the inflationafter observing the supply shock. It means that this policy makes reaction for that supply shock. This additional information advantage makes the CB plays an important rule of stabilization. It also explains why it is more frequent to change monetary policy than change nominal wage and price. This means that the CB makes reaction to supply shock before the private agency’s modification for nominal contract. If there is no supply shock (), solve the Lagrangian to
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