Central Bank Behavior Research Articles

Real Exchange Rate Persistence and Systematic Monetary Policy Behaviour

This paper estimates forward-looking monetary policy rules for Germany over the 1979-98 period and for the United Kingdom for the periods 1979-90 and 1992-98. The estimation results indicate that there were substantial differences between systematic monetary policy in Germany and in the United Kingdom, as well as shifts in systematic monetary policy in the United Kingdom, over this period. The paper analyses the implications of these estimated policy rules for real exchange rate behaviour in an open economy dynamic stochastic general equilibrium model. The analysis shows that real exchange rate persistence could be attributed to the persistence of real shocks and interest rate smoothing behaviour of central banks. However, the observed cross-country asymmetry in systematic monetary policy behaviour elevates real exchange rate persistence to realistic levels, whereas changes in asymmetric policy behaviour alter the character of real exchange rate persistence.

A Comparison Between the Fed and the ECB: Taylor Rules

This paper analyzes whether Taylor-type policy rules can be used to describe the behavior of the Federal Reserve and the European Central Bank from the beginning of 1999 until mid 2002. Since there was no common monetary policy for the Euro area before 1999, we examine if the average Central Bank behavior of the countries forming the European Monetary Union can be approximated by a single reaction function. We compare the currency areas by searching for similarities and distinctions between the Taylor-type reaction functions of the two central banks. We pay particular attention to the possible influence of one central bank on the behavior of the other one. The simplest method to test this interdependence is to compare the two reaction functions and try to incorporate the decision variable of one central bank into the other central bank's reaction function. The estimations show that there are significant differences in the reaction functions of both central banks before and after 1999 and between the two central banks. The second result is that the Fed seems to influence the ECB but not vice versa.

Monetary Policy and Central Bank Behaviour

This paper surveys the state of the art on monetary policy and central bank behaviour from a public choice perspective. After a brief look at the roots of today's view of monetary policy conduct and institutional design in early work on political business cycles, the inflation-stabilisation dilemma is discussed along with proposed solutions in the form of central bank independence and conservativeness, incentive contracts, and inflation targets. The final section turns to current developments, including the proper choice of policy targets, the role of New Keynesian aggregate-supply curves and the quest for monetary policy rules triggered by the Taylor rule.

Assessing monetary rules performance across EMU countries

AbstractThe topic covered in this paper is the performance of different monetary policy rules used as guidelines in practical policy making. To this end, different rules are evaluated using alternative econometrics techniques. A comparative analysis is made of the ability of the rules to correspond to the historical central bank behaviour and of the volatility of output, inflation and interest rate changes that they imply. The study is conducted of the EMU countries. The results suggest that simple rules perform quite well and that the advantages obtained from adopting an optimal control‐based rule are not so great. Moreover, the addition of a forward‐looking dimension and of an interest rate smoothing term in the reaction function seems to improve the performance of the rules. Copyright © 2003 John Wiley & Sons, Ltd.

Comment on "Taking Intermediation Seriously"

Comment on "Taking Intermediation Seriously" David Altig (bio) and Bruce D. Smith In April 2003, the University of Texas, Austin, the Federal Reserve Bank of Minneapolis, and the Federal Reserve Bank of Cleveland co-sponsored a conference in Austin, Texas, in honor of the contributions and in the memory of Bruce Smith. The program, which included eight presentations over two days, was remarkable in that it consisted almost entirely of papers representing work in which Bruce was engaged at the time of his death. "Taking Intermediation Seriously," was one of those papers. Originally, Steve Williamson was slated to serve as one of the discussants for the paper at the November 2002 conference represented by this volume. Graciously, Steve agreed to step in and present the paper in Cleveland, as he was to later do in Austin. Although David Andolfatto would be the only discussant at the Cleveland meeting, I had the honor of serving in the discussant's role at the Texas meeting. I have chosen to exercise my prerogative as editor of this volume, and include my Austin remarks herein. I do so in the hope of highlighting, one more time, the truly remarkable contributions of Bruce's work. To a large extent, this is entirely unnecessary. Those contributions can be easily appreciated by perusing the list of his publications provided in the March 2002 edition of the Minneapolis Fed's Quarterly Review, by noting the astounding number of coauthors with whom he collaborated, or simply inquiring as to his influence on those of us lucky enough to have come into his orbit. But here I wish to emphasize an element of Bruce's efforts that would be too easy to overlook: his abiding interest in the application of economic theory and history to the practice of policymaking. "Taking Intermediation Seriously," which collects and organizes the issues that had absorbed much of Bruce's interest and energy over the last part of his career, makes the point. In this paper, Bruce points to the future directions that he firmly believed held the most promise for progress in monetary and macroeconomic [End Page 1367] theory. At the same time, the theory and evidence presented in the paper speak directly to front-burner issues of contemporary monetary policy. I will discuss some of these, in the form of three questions to which "Taking Intermediation Seriously" is directly relevant: What is the "right" rate of inflation? Is deflation problematic? Is our current understanding of the monetary transmission mechanism adequate? 1. The "Right" Rate of Inflation: Motivating Central Bank Behavior Figure 1 illustrates the target bands for several countries with explicit quantitative inflation objectives. The similarity of the chosen ranges is striking. The target range is currently 1% to 3% annually for both Canada and New Zealand, and 1.0% to 3.0% in Sweden. The targeted inflation rate in the United Kingdom is 2.0%, with a tolerance range of ±1 percentage point, outside of which the Bank's Monetary Policy Committee is obliged to explain its performance. The European Central Bank (ECB) expresses its objective as less than 2.0% price-level growth (over the "medium term"), and does not directly articulate a lower limit. However, Ottmar Issing, a member of the ECB's Executive Board, has forcefully argued that the Bank's objective "was clearly intended from the start to mean neither prolonged inflation nor prolonged deflation."1 Issing goes on to argue that "the experience and analyses of recent years have shown that ... inflation and interest rate levels excessively close to zero entail risks of deflation and reduce the scope for monetary policy action."2 In the light of these comments, it would be easy to infer that the operational target for the ECB is in the neighborhood of 1% to 2.0%. There is not much doubt that central bankers in the United States are generally sympathetic to the objective that is expressed in more explicit terms by inflation-targeting central banks. Since the last significant break in the U.S. inflation trend in the early part of the 1990s, annual CPI inflation rates have not been allowed to exceed 3.5%. On the other hand, it is...

Introduction: Recent Developments in Monetary Macroeconomics

IntroductionRecent Developments in Monetary Macroeconomics David Altig The contents of this volume hardly require explanation beyond its title: "Recent Developments in Monetary Macroeconomics." Our intent for the conference was to collect a set of papers reflecting the cutting edge of applied monetary macroeconomics. As befitting such an ambitious-sounding goal, the contributions are wide ranging. For purposes of this brief introduction, however, we might organize the papers as answers to three questions. (1) What is the "optimal" Taylor rule? (2) Are "New Keynesian" or "New Neoclassical Synthesis" models the final word on the monetary transmission mechanism? (3) Is there a role for money in the conduct of monetary policy? What is the "Optimal" Taylor Rule The inclusion of the Taylor rule issue is almost a prerequisite for any collection of papers purporting to survey recent developments in monetary macroeconomics. In policy discussions, the Taylor rule is ubiquitous, and it is currently the choice among alternative specifications of central bank behavior. More precisely, perhaps, the general form of the Taylor rule is the choice, as it has come to represent the general class of equations that relate the federal funds rate to some measure of an output gap and inflation rate. There is substantially less unanimity about whether output gaps and inflation rates should be past, present, or (expected) future values, whether past values of the funds rate need to be included, and what are the appropriate magnitudes of the responses to each of these measures. Marc Giannoni and Michael Woodford offer the natural approach to addressing the dispute: find the representation that is optimal within the framework being employed for policy analysis. The model in question here is essentially a derivative of the "New Neoclassical Synthesis" class of models that are currently the workhorses of most monetary policy analyses among academic and central bank staffs alike. Their approach to discovering the optimal policy within this structure has the flavor of [End Page 1039] the "Ramsey problem" familiar from optimal tax policy, although with the strong requirement that the derived policy rule be "robustly optimal": it must support the optimal equilibrium no matter what the distribution of disturbances the model policymakers face. Giannoni and Woodford offer two essential lessons. First, whether optimal policy incorporates forecasts of future price-level growth or output gaps depend critically on the dynamics of the inflation rate. If the adjustment of the price-level to shocks is inertial, then optimal policy necessarily depends on forecasts of future inflation. Second, the response of the funds rate to its own past is inertial. In fact, it is super-inertial, meaning that (all else equal), the contemporaneous funds rate responds more than one-for-one with the lagged value of the funds rate (and lagged changes in the rate). The proposition that monetary authorities ought to aggressively respond to lagged values of the funds rate also arises in the papers by Jess Benhabib, Stephanie Schmitt-Grohé, and Martín Uribe, and George Evans and Seppo Honkapohja. In the latter case, the authors consolidate and expand on their well-known work on learning dynamics. A central contribution of the work presented in this article is the notion that convergence to a unique rational expectations equilibrium under learning, as well as the stability of that equilibrium, serves as basis for the choice (or rejection) of an optimal policy formulation. An apparent lesson from Evans and Honkapohja's analysis is that the learnability criterion prescribes a policy rule that differs in some important ways from the conventional wisdom coming from analyses that invoke the Taylor rule in a pure rational expectations environment. In particular, they conclude that the optimal policy rule in the environment they consider requires the monetary authority to respond directly to private-sector expectations. The environment they consider is essentially the same as in Giannoni and Woodford, with the exception of the central bank's assumed loss function: Giannoni and Woodford assume a preference for interest rate smoothing, Evans and Honkapohja do not. In his comments, John Duffy points out that the introduction of interest-smoothing motive yields an optimal policy rule under learning that is much closer to the conventional view. In particular, it does not require...

The Changing Face of Central Banking: Evolutionary Trends since World War II

List of figures List of tables Preface 1. The institutional make-up and evolution of central bank-government relations: an introduction 2. Legislation alone does not a central bank make: political structure, governance and reputation in monetary policy 3. Central bank personalities and monetary policy performance 4. Econometric analysis of central bank behavior: an evolutionary approach 5. Contrasting quantitative and qualitative assessments of central bank behavior and the evolution of monetary policies 6. Accountability, disclosure and conflict resolution 7. Inflation targets versus other inflation control measures: two sides of the same coin? 8. The changing face of central banking: epilogue Bibliography Index.

Monetary Policy Rules: What Are We Learning?

:The paper shows that the “monetary policy rules and inflation targeting” literature and the” endogenous money” literature share a reaction function approach to central banking policy. Monetary aggregates are the outcome of the price-maker and quantity-taker behavior of central banks in the reserve market, and of banks in the loans market. However, the paper argues that any process of convergence between those two approaches has to confront the following four critical areas: (a) the meaning of endogenous money, (b) the theory of inflation, (c) the theory of interest rates, and (d) the long-run role of money.

Nominal Wage Flexibility, Wage Indexation and Monetary Union

Membership in a monetary union implies stronger incentives for nominal wage flexibility in the form of wage indexation and shorter contract length than nonmembership. For example, entry into a monetary union may cause a move from a non-indexation to an indexation equilibrium. But more wage flexibility is only an imperfect substitute for an own monetary policy. It is possible that an increase in wage flexibility is welfare-decreasing because of the accompanying rise in price variability. The interaction between wage setting and central bank behaviour may result in either multiple equilibria or a unique full-indexation equilibrium.

Foreign reserve and money dynamics with asset portfolio adjustment: international evidence

In this paper we argue that more complete modeling of foreign exchange intervention and sterilization dynamics is necessary when there are adjustment costs to changing private portfolios and/or the central bank attempts to balance longer-run monetary control against short-term exchange rate objectives. We show that measured correlations between domestic credit and foreign asset changes, often interpreted as ‘sterilization coefficients’, may be misleading because they vary with the pattern of disturbances as well as private agent and central bank behavior. We assess the empirical significance of this issue by estimating vector error correction models of the domestic and foreign asset components of the monetary base for Japan and Germany. In both countries, we find that that the impact of foreign exchange intervention on domestic credit falls markedly after several months, implying that the degree of sterilization decreases over time. However, the monetary base remained largely insulated as foreign asset positions were subsequently ‘unwound.’

Independencia del banco central e inflación: el caso de Colombia, 1924 - 1998.

This paper evaluates the link between central bank independence and inflation for the case of Colombia. It develops a theoretical framework concerning central bank independence and inflation. It concludes that central bank independence is an important feature for reducing inflation and partially solvind the problem of time inconsistency, assuming the existence of a monetary dominant regime Central Bank Independence has led to a reduction in inflation and its variability in Colombia. However, the results for inflation in the last period have not been so impressive. The paper suggests alternative explanations for this result. Real independence of the Colombian Central Bank may be lower than its formal independence. Also, other factors besides Central Bank behaviour may account for higher-than-expected inflation rates in Colombia, particularly the existence of an externally financed fiscal deficit.

Does Talk Matter After All?: Inflation Targeting and Central Bank Behavior

Interpretations of inflation (IT) have ranged widely, from inflation-only targeting without regard for output, to cheap talk without effect, to transparency increasing flexibility without cost. We characterize five interpretations of the adoption of IT as shifts between strategies in a conventional model of monetary time-inconsistency. Their implications for central bank behavior are compared to the time-series properties of inflation, and to the response of interest rates to inflation movements, for three countries adopting IT in the early 1990s. For the U.K. and Canada, lower inflation levels and persistence post-adoption are combined with greater accommodation of real shocks and more stable private-sector inflation expectations. This is consistent with successful approximation of the optimal state-contingent rule. The results for New Zealand post adoption mix reduced inflation level and persistence with less stable inflation expectations, perhaps reflecting increased rule-like conservatism. There is no evidence, however, that IT entails a single-minded pursuit of the inflation target.

Money growth targeting by the Bundesbank

The recent debate over monetary strategies concludes that monetary and inflation targeting lead to very similar patterns of central bank behavior. Why, then, do central banks insist on the strategies they use. In this paper, we develop an answer from political economy, arguing that monetary strategies are helpful in solving internal and external coordination problems for the central bank. We illustrate the point by reviewing the Bundesbank's experience with money growth targeting in the mid-1970s. Monetary targeting was a signal that the previous monetary regime had been overcome, and a means to define the role of monetary policy vis-à-vis other players in the macroeconomic policy game, and to structure the internal monetary policy debate.

Does adoption of inflation targets affect central bank behaviour ? A comment

Does adoption of inflation targets affect central bank behaviour ? A comment

Does adoption of inflation targets affect central bank behaviour ? A comment

Does adoption of inflation targets affect central bank behaviour ? A comment

Does adoption of inflation targets affect central bank behaviour

Does adoption of inflation targets affect central bank behaviour

Monetary Policy in Japan: A Structural VAR Analysis

This paper studies the objectives and operating procedures of the Bank of Japan (BOJ) during the period 1975–1994. It uses a modified version of the structural VAR of Bernanke and Mihov, which nests several alternative hypotheses concerning central bank behavior. The approach allows for separate identification of the anticipated and unanticipated components of monetary policy, and it is capable of distinguishing between interest rate targeting and various types of reserve targeting. Three main results emerge from the analysis. First, no single target can explain the BOJ's behavior. Instead, the BOJ appears to weight both variation in the call money rate and variation in nonborrowed reserves, with the weight on the call money rate increasing over time. Second, there is strong evidence that at times the BOJ has employed “moral suasion” to counter shocks in the demand for borrowed reserves. However, by the second half of the 1980s, this procedure was no longer being used. Third, plots of the overall stance of monetary policy and its unanticipated component clearly reveal that a sharp monetary contraction occurred between early 1990 and late 1992, with an equally sharp expansion since then. Perhaps surprisingly, both the contraction and the subsequent expansion appear to have occurred largely in response to prevailing economic conditions, rather than as an unanticipated change in policy.J. Japan. Int. Econ., September 1997,11(3), pp. 275–295. Federal Reserve Bank, of San Francisco, 101 Market Street, San Francisco, California 94105; and Department of Economics, Santa Clara University, Santa Clara, California 95053.

Inflation Regimes and Inflation Expectations

There has been much talk in the popular press about the difficulty of attaining credibility in the bond markets for the low-inflation policies that have been adopted by a number of central banks in recent years. This credibility problem is particularly severe for those countries that have a history of high inflation. Gaining credibility is often viewed in the context of learning by the public about the central bank’s true intentions. However, this paper argues that a more important aspect of credibility – at least for long-term inflation expectations – may be public views about how future changes in personnel, electoral results, or economic shocks may affect central bank behaviour. In other words, there is always a positive probability that the current regime will end. Views about the nature of possible future regimes are likely to be influenced by observed past regimes.

The bureaucratic and partisan behavior of independent central banks: German and international evidence

Central bank staff depends positively on the country's population size, its per capita income and the central bank's independence with respect to salaries. In the developing countries, exchange rate pegging can reduce central bank staff. Among the industrial countries, France, Belgium/Luxembourg and Germany have the most overstaffed central banks. In Germany, central bank revenue has a significantly positive effect on staff size. A non-parametric test for the German Bundesbank confirms the hypothesis that monetary expansion (M1) accelerates when the government has a political majority in the central bank council at the beginning of the pre-election period or when the political majority in the council changes in favor of the government during the pre-election period (and that monetary expansion decelerates if the reverse is true).

Inflation Regimes and Inflation Expectations

There has been much talk in the popular press about the difficulty of attaining credibility in the bond markets for the low-inflation policies that have been adopted by a number of central banks in recent years. This credibility problem is particularly severe for those countries that have a history of high inflation. Gaining credibilty is often viewed in the context of learning by the public about the central bank's true intentions. However, this paper argues that a more important aspect of credibility--at lease for long-term inflation expectations--may be public views about how future changes in personnel, electoral results, or economic shocks may affect central bank behavior. In other words, there is always a positive probability that the current regime will end. Views about the nature of possible future regimes are likely to be influenced by observed past regimes.