Which of the following is the most appropriate model for a central bank conducting discretionary stabilization policy?
A) observe what the unemployment rate has been in recent periods, estimate the difference from the natural rate, and adjust the money supply accordingly
B) observe the current level of GDP, estimate the output gap between actual and potential GDP, and adjust bank reserve requirements accordingly
C) observe the past and current trade-weighted exchange rate, estimate the difference from purchasing power parity, and adjust income taxes accordingly
D) predict the future inflation rate based on current and recent trends in economic variables, estimate the difference from the target rate, and tighten or loosen lending accordingly
E) disregard current trends and simply keep the money supply growing at a rate equal to the long run growth rate of GDP

Question

Quizplus · Accepted Answer

Option D involves using inflation targeting as a means of conducting discretionary stabilization policy. The central bank estimates the difference between current and target inflation rates and adjusts lending policies accordingly. This approach is widely used by many central banks around the world. The other options involve attempting to stabilize the economy using variables that may not have a direct impact on the business cycle, such as exchange rates or long-term growth rates.

Which of the Following Is the Most Appropriate Model for a Central