Presentation on theme: "The Conduct of Monetary Policy: Strategy and Tactics"— Presentation transcript:
1 The Conduct of Monetary Policy: Strategy and Tactics Chapter 16
2 Monetary Targeting I United States Fed began to announce publicly targets for money supply growth in 1975.Paul Volcker (1979) focused more on nonborrowed reservesGreenspan announced in July 1993 that the Fed would not use any monetary aggregates as a guide for conducting monetary policy2
3 Monetary Targeting II Japan In 1978 the Bank of Japan began to announce “forecasts” for M2 + CDsBank of Japan’s monetary performance was much better than the Fed’s duringIn 1989 the Bank of Japan switched to a tighter monetary policy and was partially blamed for the “lost decade”3
4 Monetary Targeting III GermanyThe Bundesbank focused on “central bank money” in the early 1970s.A monetary targeting regime can restrain inflation in the longer run, even when targets are missed.The reason of the relative success despite missing targets relies on clearly stated monetary policy objectives and central bank engagement in communication with the public.4
5 Monetary Targeting Flexible, transparent, accountable Advantages Almost immediate signals help fix inflation expectations and produce less inflationAlmost immediate accountabilityDisadvantagesMust be a strong and reliable relationship between the goal variable and the targeted monetary aggregate5
6 Inflation Targeting IPublic announcement of medium-term numerical target for inflationInstitutional commitment to price stability as the primary, long-run goal of monetary policy and a commitment to achieve the inflation goalInformation-inclusive approach in which many variables are used in making decisionsIncreased transparency of the strategyIncreased accountability of the central bank6
7 Inflation Targeting II New Zealand (effective in 1990)Inflation was brought down and remained within the target most of the time.Growth has generally been high and unemployment has come down significantlyCanada (1991)Inflation decreased since then, some costs in term of unemploymentUnited Kingdom (1992)Inflation has been close to its target.Growth has been strong and unemployment has been decreasing.7
8 Inflation Targeting III AdvantagesDoes not rely on one variable to achieve targetEasily understoodReduces potential of falling in time-inconsistency trapStresses transparency and accountabilityDisadvantagesDelayed signalingToo much rigidityPotential for increased output fluctuationsLow economic growth during disinflation8
9 Inflation TargetsSource: Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin, and Adam S. Posen, Inflation Targeting: Lessons from the International Experience (Princeton: Princeton University Press, 1999), updates from the same sources, and9
10 Monetary Policy with an Implicit Nominal Anchor There is no explicit nominal anchor in the form of an overriding concern for the Fed.Forward looking behavior and periodic “preemptive strikes”The goal is to prevent inflation from getting started.
11 Monetary Policy with an Implicit Nominal Anchor II AdvantagesUses many sources of informationAvoids time-inconsistency problemDemonstrated successDisadvantagesLack of transparency and accountabilityStrong dependence on the preferences, skills, and trustworthiness of individuals in chargeInconsistent with democratic principles11
12 Advantages and Disadvantages of Different Monetary Policy Strategies 12
13 Tactics: Choosing the Policy Instrument ToolsOpen market operationReserve requirementsDiscount ratePolicy instrument (operating instrument)Reserve aggregatesInterest ratesMay be linked to an intermediate targetInterest-rate and aggregate targets are incompatible (must chose one or the other).13
14 Linkages Between Tools, Policy Instruments, Intermediate Targets, and Goals 14
16 Criteria for Choosing the Policy Instrument Observability and MeasurabilityControllabilityPredictable effect on Goals16
17 The Taylor Rule, NAIRU, and the Phillips Curve An inflation gap and an output gapStabilizing real output is an important concernOutput gap is an indicator of future inflation as shown by Phillips curveNAIRURate of unemployment at which there is no tendency for inflation to change17
18 Result of Targeting on the Federal Funds Rate 18
19 Central Bank’s Response to Asset Price Bubbles Asset-price bubble: pronounced increase in asset prices that depart from fundamental values, which eventually burst.Types of asset-price bubblesCredit-driven bubblesSubprime financial crisisBubbles driven solely by irrational exuberance19
20 Lessons From the Subprime Crisis Should central banks respond to bubbles?Strong argument for not responding to bubbles driven by irrational exuberanceBubbles are easier to identify when asset prices and credit are increasing rapidly at the same time.Monetary policy should not be used to prick bubbles.20
21 Lessons From the Subprime Crisis Macropudential regulation: regulatory policy to affect what is happening in credit markets in the aggregate.Central banks and other regulators should not have a laissez-faire attitude and let credit-driven bubbles proceed without any reaction.
22 Historical Perspective I Discount policy and the real bills doctrineDiscovery of open market operationsThe Great DepressionReserve requirements as a policy toolThomas Amendment to the Agricultural Adjustment Act of 1933War finance and the pegging of interest rates22
23 Historical Perspective II Targeting money market conditionsProcyclical monetary policyTargeting monetary aggregatesNew Fed operating proceduresDe-emphasis of federal funds rateDe-emphasis of monetary aggregatesBorrowed reserves targetFederal funds targeting againGreater transparency23
24 Historical Perspective III Preemptive strikes against inflationPreemptive strikes against economic downturns and financial disruptionsLTCMEnronSubprime meltdownInternational policy coordination24
25 The Taylor Rule for the Federal Funds Rate Source: Federal Reserve: and author’s calculations.
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