17.2 Central Bank Goal Trade-offs #Notebook

17.2 Central Bank Goal Trade-offs #Notebook

Central banks often get themselves in a dilemma, in which price stability, inflation control, economic growth, and employment. Although in the long run, the two goals are compatible, they sometimes are not in the short run.

Central banks have to make hard decisions.....

Raise interest rates or slow or even stop MS growth to stave off inflation? 

Or, decrease interest rates, speed up MS growth to induce companies and consumers to borrow to stoke employment and growth? 

When central banks act as a lender of last resort to restore stability to the financial system, they create a time inconsistency problem and moral hazard. Business owners and bankers take on extra risks since they think they will get free favors while difficult times.

However, a little frictional unemployment is a good thing because it allows the labor market to function more smoothly. Frictional unemployment naturally occurs, even in a growing, stable economy. Workers choosing to leave their jobs in search of new ones. 

Structural unemployment, when workers’ skills do not match job requirements, is not such a good thing, but is probably inevitable in a dynamic economy saddled with a weak educational system. 

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.