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In: Economics

The economy of Lacovia has been on a downward spiral. There is high level of inflation...

The economy of Lacovia has been on a downward spiral. There is high level of inflation in the economy, unemployment is 14% and is projected to increase in the next quarter. In addition, the dollar has been depreciating gradually In order to reform the economy, the government passed a law, making price stability the sole goal of the Central Bank of Lacovia. The law stipulates that the Governor of the bank should make public by the way of a statement on how the bank intends to judge the effectiveness of monetary policy. This requires the Governor to specify numerical ranges for inflation and the dates these targets will be achieved. The Governor of the central bank is somewhat concerned about the new goal of the central bank, as before the passing of this law, he had the flexibility of choosing between price stability and full employment in the long run. a) What were the primary objectives of the Bank of Lacovia before the passing of the law? (2 mark) b) Does the Bank of Lacovia have a dual mandate or hierarchical mandate? Please provide and explanation for your answer. c) What is the monetary policy strategy that the Bank of Lacovia is employing? (1 mark) d) State the two advantages and two disadvantages of this strategy. (8 marks

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ANSWER TO QUESTION

a) The Bank of Lacovia has the flexibility of choosing between price stabilty and full employment in the long run.

b) The Bank of Lacovia has a dual mandate because the law stipulates that the Governor of the bank should make public by the way of a statement on how the bank intends to judge the effectiveness of monetary policy. This requires the Governor to specify numerical ranges for inflation and the dates these targets will be achieved. Here the tradeoff lies between maintaining price stability and full employment in the long run.

c) The Bank of Lacovia adopts price stability as the sole goal of monetray policy.

d) The concrn for price stability has both advantages and disdavantages :

Advantages

1. THe cost of input prices will be controlled. This will mainatain the cost push inflation under control.

2. The demand generation will be at its good pace.

Disadvantages

1. The drive for price stabiity might not ensure output at its full employment.

2. The exchange rate fluctuations might derail the economy from its notion of price stability.

Rahul Sunny answered 2 years ago
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