Transcript Chapter 21 - Pearson Canada

Chapter 21
Monetary Policy
Strategy: The
International
Experience
© 2005 Pearson Education Canada Inc.
Role of a Nominal Anchor
Ties Down  Expectations
Helps Avoid Time-Consistency Problem
1. Arises from pursuit of short-term goals which lead to
bad long-term outcomes
2. Time-consistency resides more in political process
3. Nominal anchor limits political pressure for timeconsistency
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Exchange-Rate Targeting
Advantages
1. Fixes  for internationally traded goods
2. Anchors  expectations
3. Automatic rule, avoids time-consistency
4. Easy to understand: “sound currency” as
rallying cry
5. Helps economic integration
6. Successful in reducing 
France, UK, Mexico
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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
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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
Dollarization
1. Even stronger commitment mechanism
2. No possibility of speculative attack
3. Usual disadvantages of fixed exchange rtae
4. Lose seignorage
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Summary: Advantages and Disadvantages of
Different Monetary Policy Strategies
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Summary: Advantages and Disadvantages of
Different Monetary Policy Strategies
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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 then reverses overshoots
4. Key elements: flexibility, transparency, and accountability
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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
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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
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Inflation
Targeting in
New Zealand,
Canada, and
the UK
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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-consistent 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
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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
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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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