ECO 304L Study Guide - Midterm Guide: Alan Greenspan, Federal Funds, Federal Funds Rate
20 Oct 2017
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The best policy described above requires the fed to act before inflation heats up. Thus, the fed would have to raise interest rates before actually seeing inflation. In academic and policy discussions this is called a pre-emptive strike against inflation. To implement such a policy effectively, the fed has to see the rise in ad above y* before unemployment falls and inflation rises. Furthermore, the fed might make a costly mistake with pre-emptive strikes. Remember that in talking about the practical challenges of fiscal policy we discussed how it is tough for policymakers to know the level of y*. Suppose actual output were below y*, but the fed thought y* had been reached. If the fed forecast a rise in ad, they might raise interest rates to strike against inflation. But the economy might actually be able to expand further without much more inflation.
