EC230 Economics in Public Policy2017 Lent TermInstructor:Mid-term AssignmentFebruary 2017.1. Explain

EC230 Economics in Public Policy2017 Lent TermInstructor:Mid-term AssignmentFebruary 2017.1. Explain

EC230 Economics in Public Policy2017 Lent TermInstructor:Mid-term AssignmentFebruary 2017.1. Explain the formation of an asset price bubble by discussing each of thelinks identified in the diagram below. 2. Consider the price stability-financial stability (PS-FS) model in which theBank of England is required to meet both an inflation target and a creditgrowth target. Illustrate your answers using graphical analysis.a) Suppose the economy enters a period of excessive optimism, in whichinflation is rising and credit growth is surging. How do the PS and FS curvesshift? How can the Bank of England meet its credit growth target if it controlsmonetary policy?b) Suppose the economy experiences a beneficial supply shock, in whichinflation is falling and credit growth is surging but still below the maximumgrowth rate consistent with financial stability. How do the PS and FS curvesshift? How can the Bank of England meet its inflation target if it controlsmonetary policy? c) Suppose that credit growth is surging but the Bank of England cannot tellwhether inflationary pressures are rising or falling. Assume its key priority isto prevent an asset price bubble from forming. What risks does it face ifcontrolling monetary policy alone, given that it does not know whether thecredit growth surge is due to an asset price bubble or an improvement ineconomic fundamentals? How might these risks be mitigated if itcontrols both monetary policy and macroprudential policy?d) Suppose the economy experiences a severe adverse shock to consumerconfidence, warranting an aggressive monetary easing so that the policy ratereaches the zero lower bound (ZLB). How might the use of macroprudentialtools provide additional economic stimulus under these conditions?

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