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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Which of the following is the strongest criticism of the view that inflation targeting and good monetary policy alone explained the Great Moderation, as discussed after the 2007-09 crisis?

The strongest criticism is that stable consumer price inflation can coexist with growing financial imbalances, such as asset price booms and rising leverage. Calm inflation therefore gave false comfort, and the 2007-09 crisis showed that price stability did not guarantee financial stability.

  1. AInflation targeting was never adopted by any central bank before 2008
  2. BLow consumer price inflation can coexist with building financial imbalances such as asset price booms and rising leverage, so stability in inflation did not ensure financial stabilityCorrect
  3. COutput volatility rose steadily throughout 1985 to 2007
  4. DCentral banks had no influence over short-term interest rates
  5. Inflation was higher in the 2000s than in the 1970s

Explanation

Critics argue that stable consumer prices masked credit and asset price build-ups that led to the crisis, so a narrow inflation focus gave false comfort. The other statements are factually wrong or irrelevant.

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