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chapter 20. Monetary Policy Strategy: The International Experience. Role of a Nominal Anchor. Ties Down  Expectations Helps Avoid Time-Inconsistency Problem 1. Arises from pursuit of short-term goals which lead to bad long-term outcomes

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chapter 20

Monetary Policy Strategy: The International Experience

role of a nominal anchor
Role of a Nominal Anchor
  • Ties Down  Expectations
  • Helps Avoid Time-Inconsistency Problem
    • 1. Arises from pursuit of short-term goals which lead to bad long-term outcomes
    • 2. Time-inconsistency resides more in political process
    • 3. Nominal anchor limits political pressure for time-inconsistency
exchange rate targeting
Exchange-Rate Targeting
  • Advantages
    • 1. Fixes  for internationally traded goods
    • 2. Anchors  expectations
    • 3. Automatic rule, avoids time-inconsistency
    • 4. Easy to understand: “sound currency” as rallying cry
    • 5. Helps economic integration
    • 6. Successful in reducing 
    • France, UK, Mexico
exchange rate targeting1
Exchange-Rate Targeting
  • Disadvantages
    • 1. Loss of independent monetary policy
    • Problems after German reunification: UK, French monetary policy too tight
    • 2. Open to speculative attacks
    • Europe, Sept. 1992; Mexico: 1994; Asia: 1997
    • 3. Successful speculative attack disastrous for emerging market countries because it leads to financial crisis
    • 4. Weakened accountability: lose exchange-rate signal
currency boards vs dollarization
Currency Boards vs. Dollarization
  • Currency Boards
    • 1. Domestic currency exchanged at fixed rate for foreign currency automatically
    • 2. Fixed exchange rate with very strong commitment mechanism and no discretion
    • 3. Usual disadvantages of fixed exchange rate
    • 4. Still subject to speculative attack
    • 5. Lose ability to have lender of last resort
  • Dollorization
    • 1. Even stronger commitment mechanism
    • 2. No possibility of speculative attack
    • 3. Usual disadvantages of fixed exchange rtae
    • 4. Lose seignorage
monetary targeting
Monetary Targeting
  • Canada
    • 1. Targets M1 till 1982, then abandons it
    • 2. 1988: declining  targets, M2 as guide
  • United Kingdom
    • 1. Targets M3 and later M0
    • 2. Problems of M as monetary indicator
  • Japan
    • 1. Forecasts M2 + CDs
    • 2. Innovation and deregulation makes less useful as monetary indicator
    • 3. High money growth 1987-1989: “bubble economy,” then tight money policy
  • Germany and Switzerland
    • 1. Not monetarist rigid rule
    • 2. Targets using M0 and M3: changes over time
    • 3. Allows growth outside target for 2-3 years, but them reverses overshoots
    • 4. Key elements: flexibility, transparency, and accountability
monetary targeting1
Monetary Targeting
  • Advantages
    • 1. Able to cope with domestic considerations
    • 2. Signals are immediate
    • 3. Immediate accountability of central bank
  • Disadvantages
    • 1. Big if: all advantages require reliable relationship between goal and targeted aggregate
    • 2. In many countries, weak relationship between goal and M-aggregate
    • Poor communications device and accountability
inflation targeting
Inflation Targeting
  • Five Elements
    • 1. Public announcement of medium-term š-target
    • 2. Institutional commitment to price stability
    • 3. Information inclusive strategy
    • 4. Increased transparency through public communication
    • 5. Increased accountability
inflation targeting1
Inflation Targeting
  • Advantages
    • 1. Allows focus on domestic considerations
    • 2. Not dependent on reliable relationship between M-aggregate and inflation
    • 3. Readily understood by public
    • 4. Reduce political pressures for time-inconsistent policy
    • 5. Focus on transparency and communication
    • 6. Increased accountability of central bank
    • 7. Performance good:  and e , and stays low in business cycle upturn
inflation targeting2
Inflation Targeting
  • Disadvantages
    • 1. Delayed signalling
    • 2. Too much rigidity
    • 3. Potential for increased output fluctuations
    • 4. Low economic growth
  • Nominal GDP Targeting
    • 1. Close to inflation targeting with concern about output fluctuations
    • 2. Problem of announcing specific target for real GDP growth
    • 3. Harder for public to understand
monetary policy with an implicit nominal anchor
Monetary Policy with an Implicit Nominal Anchor
  • Forward-Looking and Preemptive to Deal With Long Lags
  • Advantages
    • 1. Focus on domestic considerations
    • 2. Has worked very well in the U.S.
    • 3. If It Ain’t Broke Why Fix It
  • Disadvantages
    • 1. Lack of transparency and accountability
    • 2. Dependence on personalities
    • 3. Inconsistent with democratic principles
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