If the Fed has discretion to choose its own policy and announces a policy of low inflation, then:
A) the policymaker is required to make the money supply grow at a low rate.
B) private economic agents are sure to believe the announcement because it is credible.
C) private economic actors are likely to discount the policy because the Fed has an incentive to renege on its policy once expectations are formed.
D) the Fed is certain to renege on its policy once expectations are formed because then it can lower unemployment with minimum inflation.

Question

Quizplus · Accepted Answer

Private economic actors may discount the Fed's policy announcement because the Fed has discretion to change its policy in the future. Since low inflation may be costly in the short run, the Fed may have an incentive to renege on its policy once expectations are formed. This is known as the time-inconsistency problem of monetary policy.

If the Fed Has Discretion to Choose Its Own Policy