Question # 19

Impact of Inflation Targeting by the Fed. Assume the Fed adopts an inflation-targeting
strategy. If oil prices rise abruptly by 15 percent in response to an oil shortage, describe
how the Feds monetary policy would be affected by this situation. Do you think the
inflation-targeting strategy would be more or less effective in this case than if the Fed
balances its inflation concerns with unemployment concerns? Explain.
For the explanation of the question, we have to know first what is inflation targeting. Actually
inflation targeting is an economic policy by which a Central Bank estimates and makes public a
projected, or "target", inflation rate and then attempts to steer actual inflation towards
the target through the use of interest rate changes and other monetary tools.
Inflation targeting is straightforward, at least in theory. The Central Bank forecasts the future
path of inflation and compares it with the target inflation rate (the rate the government believes is
appropriate for the economy). The difference between the forecast and the target determines how
much monetary policy has to be adjusted. Some countries have chosen inflation targets with
symmetrical ranges around a midpoint, while others have identified only a target rate or an upper
limit to inflation.
For our discussion we can says that if oil prices suddenly rise by 15 percent in response to an oil
shortage, as Feds inflation targeting strategy, it will need to use a tight (restrictive) monetary so
that it can attempt to slow economic growth and reduce pressure on inflation. However, in this
situation, the inflation is caused by an oil shortage, not by an excessive demand for products.
Therefore, the policy will not necessarily cure the oil price shock, and could also cause a
recession.

Question # 20
Monetary policy today. Assess the economic situation today. Is the administration more
concerned with reducing unemployment or inflation? Does the Fed have a similar opinion?
If not, is the administration publicly criticizing the Fed? Is the Fed publicly criticizing the
administration? Explain.
Monetary policy is one of the ways by which monetary authority of a country attempts to control
the economy. If the money supply grows too fast, the rate of inflation will increase; if the growth
of the money supply is slowed too much, then economic growth may also slow. The official
goals usually include relatively stable prices and low unemployment. For the discussion we have
to know first what is unemployment and what inflation is.
Unemployment:
Unemployment is defined as a situation where someone of working age is not able to get a job
but

would like to be in full time employment. An economic condition marked by the

fact that individuals actively seeking jobs remain unhired. Unemployment is expressed as a
percentage of the total available work force. The level of unemployment varies with economic
conditions and other circumstances.
Inflation:
Inflation means a sustained increase in the aggregate or general price level in an economy. It
means there is an increase in the cost of living and your money wont buy as much today as you
could yesterday. Central banks attempt to stop severe inflation, along with severe deflation, in an
attempt to keep the excessive growth of prices to a minimum.
Unemployment or inflation, Feds opinion:
For Bangladesh perspective inflation is on a rising trend and unemployment rate is also
increasing in recent years which imply that the strategies and policies of the government to
achieve 8 percent GDP growth rate by FY 2014- 15 need re-working to address these problems
for bringing the economy on track to achieve the target. Unemployment is a great concern in
Bangladesh. So, unemployment is more focused an administration concern of Bangladesh. Every
year hundreds of thousands student are coming out from college and university. Only a tiny
fraction of total jobless is managed by different government offices and private organization but

a majority remain unemployed. Besides that, the economy of Bangladesh has been suffering
from a double-digit inflation.
In terms of administration perspective of Bangladesh, reducing unemployment rate is more
concern rather than inflation. The main objective of our employment policy is the generation of
productive employment and transforming unskilled population into semiskilled and skilled.
But in terms of Central Bank of Bangladesh, it should pay more attention inflation than
employment. For Achieving its inflation targets BB provide sufficient space in its monetary
program for lending to activities which support broad-based investment and inclusive growth
objectives. In the favor of this statement is given bellow:
First, the modern macroeconomic models that the Central Bank uses for guidance have a
property known as the Taylor principle. According to this principle, the Fed should respond far
more aggressively to inflation than to unemployment.
Second, if employment is slow to recover, the Central Bank can blame it on other things such
as structural problems in the economy, the difficulties of recovering from balance sheet
recessions, problems in international scenario, international competition, technology, and so on.
But while short-run bursts of inflation can be blamed on factors such as oil and food prices, it is
not as easy to find scapegoats for high and persistent inflation. Thus, while the Fed can
potentially deflect criticism over a slow recovery of employment, it will take the blame for
persistent inflation problems.
Thus, if the Central Bank of Bangladesh has to make a choice as it may need to do it will
choose to battle inflation first and foremost. Employment problems will once again take a back
seat to worries about inflation.

Question # 21
How the Central Bank Should Respond to Prevailing Conditions. Consider the existing
economic conditions, including inflation and economic growth. Do you think the Fed should
increase interest rates, reduce interest rates, or leave interest rates at their present levels?
Offer some logic to support your answer.
The Fed has taken aggressive action using unprecedented strategies in response to the financial
crisis. The Fed's actions to stabilize the financial system, respond to the recession, and address
the safety and soundness of banking institutions are examined here.
Present inflation rate of Bangladesh was recorded at 7.04 percent in July of 2014. As per
economic growth of Bangladesh, gross domestic production is Tk.7,430,426 million. In which
Agricultural production is Tk.1,213,652 million, Industrial is Tk.2,200,445 million and Service
sector production is Tk.4,016,329 million. Central Bank usually controls interest rate and money
growth through Monetary policy. By using monetary policy, Bangladesh Bank, Central Bank of
Bangladesh can affect the interaction between the demand for money and the supply of money,
which affects interest rates, aggregate spending, and economic growth. As it increases the money
supply, interest rates should decline and result in more aggregate spending and higher economic
growth. As it decreases the money supply, interest rates should increase and result in less
aggregate spending (because of higher financing rates), lower economic growth, and lower
inflation.
In terms of Bangladesh, Bangladesh Bank should decrease interest rate in this situation. Because
1. For employment opportunity: in terms of employment opportunity we know that, if
rate of interest rate is low, many businesses commence to raise. Business set up costs
including costs of living are also low in this situation. This condition encourages various
to set up more businesses. This may also helps to increases new employment opportunity
in these businesses.
2. Cheaper borrowing costs: Lower interest rates make the cost of borrowing cheaper. It
will encourage consumers and firms to take out loans to finance greater spending and
investment.

3. Rising asset prices: Lower interest rates make it more attractive to buy assets such as
housing. This will cause a rise in house prices and therefore rise in wealth. Increased
wealth will also encourage consumer spending as confidence will be higher.
4. Use of huge idle fund: In Bangladesh, old a huge amount of fund remains idle. To utilize
this huge fund interest rate should decrease to investment and provide loan in business
sector.
5. To make Financial Institutions (NBFI, Bank) business profitable: It is very much
difficult to running business like Bank, leasing company etc. if the rate of interest is high.
If the rate of interest is high, these institutions fail to utilize its fund properly and get loss
in their business.
6. Rolling the economy perfectly: It seems that for last few months economy is slowmoving. Because of high interest many businesses and entrepreneurs are not interested to
take loan from the bank or other financial institutions. By lowering interest rate, Central
Bank can encourage these institutions or entrepreneurs to investment and flourish the
economy.
From the discussion we can see that, for present scenario the Central Bank of Bangladesh should
reduce interest rate for the betterment of the country.