Islamic Financial Solution

Chapter 16 Homework Solutions

1. “Unemployment is a bad thing, and the government should make every effort to eliminate it.” Do you agree or disagree?

Disagree. Unemployment can be classified into three categories: frictional, structural, and cyclical. Frictional unemployment occurs when people are moving between jobs or entering into the workforce and taking some time to find the job that best matches their skills. Frictional unemployment is a desirable part of a healthy and growing economy, as it indicates that resources are being efficiently allocated. Structural unemployment results from long-run inefficiencies in labor markets caused either by policy or by globalization and technical change leading to a long-run mismatch in skills and job demands. Unemployment caused by a minimum wage that is set too high or unions exerting monopoly labor power would be classified as structural. So too would someone who loses their job due to increased trade (a shift in production away from their industry and toward others) and cannot acquire the necessary skills to gain employment in other sectors of the economy. While government policy could be aimed at structural unemployment, it is not clear that monetary policy with its relatively short-run focus can do anything about it. Finally, we have cyclical unemployment which results from increases and decreases in consumer (and therefore labor) demand during business cycles. If you are cyclically unemployed, you are likely to get your job back only when the economy recovers from a recession and moves into an expansion. As monetary policy can hasten this process, this is the unemployment that a central bank can effectively target.

2. Classify each of the following as either a policy instrument or an intermediate target and explain why.

a. The ten-year Treasury bond rate

This is an intermediate target since it is not directly affected by the tools of monetary policy (non-borrowed reserves, discount...