Question

Comment on the ability of a credible nominal anchor to allow policy makers to exploit a short-run trade-off between unemployment and inflation.

Answer 1

There are two possible anchors used the by the government as signals for showing their committment towards a reform in economic policies. Policy-makers who have a strong commitment and are more willing to bring some reforms in the country, would opt for more visible policies that are made credible using an exchange-rate anchor. In contrast there can be policy-makers who are not careful enough and would not like to carry through with serious reform. These would then opt for noisier signals that include a money anchor.

Now we know that there can be short run tradeoff between unemployment and inflation where expansionary policies reduce unemployment and increase inflation. It then depends on how committed the government is to use these nominal anchors wisely. An increased visibility makes it easier for the public to seek and explore the true nature and spirit of the policies of the government. Policy-maker that are truly committed for bringing out reforms also want this to happen quickly.