ial intermediaries. It's a non monetary model so that private banking institutions or monetary variables are not essential in the NCM framework.
There is some question about the role for investment. Basic analysis is taken for households optimizing their utility function in terms of time path of consumption. Investment is used for the expansion of capital stock to increase income. Investment ensures the adjustment of capital stock to the predetermined time path. By assumption there is no impact on the capital stock. It's still lack of any effect of variations in private spending upon the economy's productive capacity (Woodford 2003:352).
Phillips curve with inflation based on current output gap, past and future inflation, expected changes in nominal exchange rate and expected world price. The model allows for sticky prices, the lagged price level in this relationship, and full price flexibility in the long run. It is assumed that b2 + b3 + b4 = 1 in equation 2, it will imply to a vertical Phillips curve. The real exchange rate affects the demand for imports and exports, and also the level of demand and economic activity. The term in equation 2 captures the forward-looking property of inflation. It implies that the success of a central bank in containing inflation depends not only on its current policy stance, but also on what economic agents perceive that stance to be in the future.
The economic agents are in a position to know how economy work & the consequences of their actions that take place today for future, so they need to know how monetary authorities would react to macroeconomic development. The practice of modern central banking can be described as the management of private expectations. The term can be seen to reflect central bank credibility. If a central bank can credibly signal its intention to achieve and maintain low inflation, then expectations of inflation will be lowered and this indicates that it may be possible to reduce current inflation at a significantly lower cost in terms of output. Therefore with this way the monetary policy operates through expectations channel. This forward looking Phillips curve could produce credibility problems known as inflation bias and the stabilization bias. The inflation bias can come about in view of imperfect competition and the stabilization bias is due to lack of central bank reputation and credibility therefore inability to influence inflation expectations through the expectations channel (Gali and Getler 2007).
Monetary policy where nominal interest rate based on expected inflation, output gap, deviation of inflation from target and equilibrium real rate of interest. The operating rule, implies that policy become a systematic adjustment to economic development in predictable manner. It says that nominal rate of interest is the sum of the real interest rate and expected inflation and therefore it may incorporate a symmetric approach to inflation targeting.
Implying that monetary policy operates with random shocks. In the tradition of Taylor rules where the exchange rate is assumed to play no role in the setting of interest rate except the changes in the exchange rate have an effect on the rate of inflation which would feed into the interest rate rule. The neutrality of money property is assumed, so that doubling the stock of money would have no effect and consequently, the stock of money is merely a residual in this model.
There are 4 further characteristics of this equation.
