Question

Discuss the implications of a higher degree of uncertainty about the effects of monetary policy on output. What would happen if the range of model predictions increased?\

Answer 1

Monetary policy is the policy used by the central government in order to control the supply of money and demand for money. In any economy people usually predict about the federal rate based on historical data or by the way of Taylor method. Uncertainty may be higher or lesser.

Higher degree of uncertainty regarding monetary policy is associated with greater volatility of inflation and unemployment and ultimately the growth level which is the result. Uncertainty occurs when the federal rate is different from the rates predicted by people based on historical data. They don't consider the price stability and effect of interest rate if fed target rate is different. It has implications on economy in terms of their wealth, purchasing power, income inequality. As in simple terms, higher inflation volatility leads to increase in cost of goods ,things become more expensive as a result there is unexpected distribution of wealth because due to increased in cost some get benefits while consumer faces burden and future predictions are failed and output goes down . Our risk premium is getting higher. Higher unemployment volatility have an impact on growth also. As due to higher volatility income is not fixed, purchasing power get reduced, morale of employees goes down and ultimately output effected by that. Growth is considered to be there when all these things or factors in economy support.

Hence, due to higher degree of uncertainty about monetary policy it will result in greater volatility of growth.

Predictions model is used to predict the rate of one value based upon some other value of variables. If the range of prediction model increases it may have good or bad effect on economy. Prediction model is like forecasting here. If our range of forecasting about the rates of monetary policy then people are able to predict whether rate in future will increases or decrease and based upon that they used their money in such a way so that they get more benefits. If they think that rates are going to be increased then they prefer to not to invest their money in any project rather then they will deposit it into bank in order to get higher interest. So it may sometimes positive for economy and sometimes it creates problem of inflation and deflation.