what should central banks do monetary policy goals, strategy and tactics

Central bank announces it will achieve a certain value (the target) of the annual growth rate of a monetary aggregate. Central bank then is accountable for hitting the target Monetary targeting was adopted by several countries: Germany, Switzerland, Canada, the U.K., Japan and the U.S.

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Chapter 18

What Should Central Banks Do?

Monetary Policy Goals, Strategy

and Tactics

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Copyright  2011 Pearson Canada Inc 18 - 2

Monetary Targeting Strategy

• Central bank announces it will achieve a

certain value (the target) of the annual growth rate of a monetary aggregate.

• Central bank then is accountable for hitting

the target

• Monetary targeting was adopted by several

countries: Germany, Switzerland, Canada, the U.K., Japan and the U.S.

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Monetary Targeting

• Flexible, transparent, accountable

• Advantages

– Almost immediate signals help fix inflation expectations

and produce less inflation – Almost immediate accountability

• Disadvantages

– Must be a strong and reliable relationship between the

goal variable and the targeted monetary aggregate

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Inflation Targeting

• Public announcement of medium-term numerical

target for inflation

• Institutional commitment to price stability as the

primary, long-run goal of monetary policy and a

commitment to achieve the inflation goal

• Information-inclusive approach in which many

variables are used in making decisions

• Increased transparency of the strategy

• Increased accountability of the central bank

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Inflation Targeting in New Zealand

• Reserve Bank of New Zealand Act 1989

• Minster of Finance and Governor of Reserve Bank to make Policy Targets Agreement

• Governor of the Reserve Bank was held accountable for the success of monetary policy

• Inflation brought down from above 5% to below 2%

by the end of 1992

• Since 1992 NZ growth rate has been high and

unemployment declined significantly

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Inflation Targeting In Canada

• In 1991, the Minister of Finance and the Governor of the Bank of Canada established formal inflation targets

• The target range was 2-4% by the end of 1992, 1.5-3%

by June 1994 and 1-3% by December 1996

• After a new government took office in 1993, the target was set at 1-3% and has been kept at this level ever

since

• Canadian inflation has fallen dramatically since the

adoption of targets, falling from 5% in 1991, to zero in

1995 and between 1-2% in the late 1990’s

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Inflation Targeting in the U.K.

• Adopted inflation target as nominal anchor in

October 1992

• Inflation target was initially set at 1-4%

• May 1997 inflation target set at 2.5% and Bank of

England was given power to set interest rates

(provided independence)

• December 2003, target was changed to 2%

• Growth in U.K economy has been strong leading to reduction in the unemployment rate

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Inflation Rates and Inflation Targets

Figure 18-1(a)

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Figure 18-1(b)

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Figure 18-1(c)

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Monetary Implicit Nominal Anchor

• U.S does not use explicit nominal anchor.

• Involves forward looking behaviour , careful

monitoring for signs of future inflation

coupled with periodic “pre-emptive strikes”

by monetary policy against threat of inflation

• Monetary policy has long lags

• Cannot wait to respond until inflation has

begun.

• Needs to be forward-looking and pre-emptive

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Advantages and Disadvantages to the U.S

• Uncertainty leads to unnecessary volatility in

financial markets, doubt among producers/general

public

• Strong dependence on the preferences, skills and

trustworthiness of the central bank staff

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Summary of Advantages and Disadvantages of

Different Monetary Policy Strategies

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Tactics: Choosing the Policy Instrument

• Tools

– Open market operation

– Government deposit shifting

– Last resort lending

– Overnight interest rate

• Policy instrument (operating instrument)

– Reserve aggregates

– Interest rates

– May be linked to an intermediate target

• Interest-rate and aggregate targets

are incompatible

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Linkages Between Central Bank Tools, Policy

Instruments, Intermediate Targets and Goals

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The Price Stability Goal

• Low and stable inflation

• Inflation

– Creates uncertainty and difficulty in planning for future

– Lowers economic growth

– Strains social fabric

• Nominal anchor

• Time-inconsistency problem

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Result of Targeting Non-borrowed Reserves

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Result of Targeting Overnight Funds

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Criteria for Choosing the Policy Instrument

• Observability and Measurability

• Controllability

• Predictable effect on Goals

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The Taylor Rule, NAIRU, and the Phillips

Curve

Overnight interest rate = inflation rate + equilibrium overnight rate + ½ (inflation gap) + ½ (output gap)

• An inflation gap and an output gap

– Stabilizing real output is an important concern

– Output gap is an indicator of future inflation as shown by

Phillips curve

• NAIRU

– Rate of unemployment at which there is no tendency for

inflation to change

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Taylor Rule and the Overnight Interest Rate

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Central Bank’s Response to Asset-Price

Bubbles

• Two Types of Asset-Price Bubbles

– Credit-Driven Bubbles

– Bubbles Driven by Irrational Exuberance

• Central Banks Response to Bubbles

• Monetary Policy and Asset-Price Bubbles

• Other Appropriate Policy Responses

– Macroprudential regulation

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Bank of Canada Historical Perspective: The

Early Years

• Bretton Wood (1945-1970s)

• 1971 flexible exchange rate with the U.S

• Expansionary MP in 1970s lead to high

inflation

• Rise of monetarism

• CB adopted key monetary aggregates as

intermediate targets of monetary policy

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Interest Rates - Canada and U.S., 1941-2009

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• Attempted to influence expectations to

reduce inflation more quickly

• Nominal exchange rate depreciated

• Nov 1982 – monetary policy was abandoned

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Inflation Targeting, 1989 – Present, II

• In 1991, the Minister of Finance and the Governor jointly announce series of declining inflation targets

• Bank uses the rate of change in the CPI as its inflation

target

• Core inflation (excludes volatile components) useful in determining trend inflation is on track for medium term

• Move to targeting directly rather than intermediate

variable represent a shift in policy

• Uses overnight interest rate as the operating target

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Inflation Targeting, 1989 – Present, III

• During 1960s and 1970s the Bank’s operation characterized by instrument and goal

opaqueness

• Explicit inflation-control target, fixed action

dates have moved Bank towards openness

and accountability

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Pre-emptive Strikes by the Bank of Canada

• Financial crisis in August 2007

• Bank of Canada easy policy stance

• Cut overnight interest rate by 25 basis points

in December of 2007

• Continued easing of monetary policy resulted

in overnight funds rate of 0.25% in April 2009

• Large injections in liquidity into credit markets

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Tiêu đề	What Should Central Banks Do? Monetary Policy Goals, Strategy and Tactics
Trường học	Pearson Canada Inc.
Chuyên ngành	Economics / Monetary Policy
Thể loại	essay
Năm xuất bản	2011
Thành phố	Canada

Định dạng
Số trang	30
Dung lượng	539 KB