Question

Consider the fact that since 2015 till the end of 2017 the central bank of Russia managed to reduce the inflation rate drastically from 16%, keeping it within their target of 4%. Also, it has been noted that after two years of recession the economy started to grow in 2017. Some commentators viewed the decline in inflation as resulting from a deliberate policy of the central bank to be more aggressive in fighting inflation. Answer the following, including appropriate diagrams:

1. How can the policy reaction function be used to analyse the action of the Russian central bank?

Answer 1

Central bank raises the interest rate to fight against the inflation as due to rise in interest rate there will be a decrease in output which leads to increase in unemployment rate. Monetary policy reaction function is an upward sloping relationship between inflation and unemployment rate. It is used in the Phillips curve and others methods to control the effects of economic policy. As Russian central bank drastically decline the inflation rate from 16% to 4%.

The MPRF has the equation:

µ = µ0 + ɸ(Π – Πt)

The Slope of the MPRF is 1/ɸ.

Here, ɸ is a parameter which shows how much unemployment rate rises when Central Bank increases the real interest rate r.

So by applying this equation, we can analyze the action of the Russian central bank.

There are other methods also like Ben Bernanke and Robert Frank's mentioned in the book principles of economics, which we can use to analyze the action of Russian central bank.