Discretionary Monetary Policy Research Articles

Trade Wars, Nominal Rigidities, and Monetary Policy

Abstract This paper shows that the outcome of trade wars for tariffs and welfare will be affected by the monetary policy regime. The key message is that trade policy interacts with monetary policy in a way that magnifies the welfare costs of discretionary monetary policy in an international setting. If countries follow monetary policies of flexible inflation targeting, trade wars are relatively mild, with low equilibrium tariffs and small welfare costs. Discretionary monetary policies imply much higher tariffs, high inflation rates, and substantially larger welfare costs. We quantify the effects of a global trade war among major economies using estimates of trade elasticities, economic size, net foreign assets, and trade openness. We find large welfare benefits of an inflation targeting monetary policy for all countries.

Exchange rate hedged deposit account as a macroprudential monetary policy instrument

Purpose - In the aftermath of the 2008 global financial crisis, central banks have resorted to macro discretionary monetary policies in order to prevent the risks that the fragility of macroeconomic indicators in national economies may pose on financial stability. Accordingly, in December 2021, the CBRT initiated a comprehensive monetary policy process that will provide long-term and permanent returns in the fight against high inflation and high exchange rates, and introduced the "Currency Protected Deposit" instrument to encourage and support real persons to make their investment preferences in TL. The liraization process and exchange rate-protected deposits are aimed to make a lasting contribution to price stability in the medium term. In this study, the purpose of the Exchange Rate Protected Deposit (ERD) scheme and its impact on macroeconomic indicators will be evaluated for the 2021-2023 period. Methodology - After explaining the implementation, characteristics and the need for the KKM, the impact of the utilization rate of the KKM on the exchange rate and interest rates in the December 2021-December 2023 period is evaluated.. Findings - With the KKM implementation, which aims to contribute to strengthening macro financial stability by supporting Turkish lira time deposits, the utilization rate of the KKM is seen to have contributed to the strengthening of the monetary transmission mechanism through the increase in the policy rate, the increase in the demand for Turkish lira instruments, and the rise in loan and deposit rates together. Turkish lira deposits are on the rise while FX-protected deposits are on the decline. Conclusion - It is observed that the KKM' implementation contributed to the lira appreciation process and partially contributed to the recovery in exchange rates between December 2021 and July 2023. Keywords: Currency protected deposit, macroprudential monetary policy, exchange rate JEL Codes: H30, E52, F31

Consecutive decentralization: The effect of central bank independence on capital account liberalization

AbstractCentral bank independence (CBI) has been widely advocated as a means to address the time‐inconsistency problem of controlling inflation. Consequently, many countries have embraced central bank reforms since the 1990s. While extant research in political science has sought to unveil the consequences of CBI, there remains an unexplained variation in the response of countries with regard to capital account openness. Notably, a positive association exists between CBI and capital account openness due to the constraints CBI places on leaders' discretionary monetary and fiscal policies, thereby fostering reliance on financial policy to boost their economies. However, this relationship is contingent on the domestic political contexts of countries. CBI leads to capital account liberalization only when the rule of law is guaranteed, given that CBI is often stipulated by laws. Therefore, in countries where political leaders can easily override formal rules, CBI shows no discernible impact on capital account openness. Employing two‐way fixed‐effects and error‐correction models, the study reveals that CBI increases capital account openness only in democracies, in the presence of multiple veto players, and a high level of transparency. The findings underscore the pivotal role of the domestic political environment in analyzing how CBI constrains political leaders.

Law and discretion in monetary policy and in the banking union: Complexity between high politics and administration

The controversy over the degree of judicial review of monetary policy decisions triggered by the contrasting Weiss judgments of the German Federal Constitutional Court and of the Court of Justice of the European Union invites an inquiry into the role of law in areas characterized by a high degree of political and technical complexity. This article singles out the structural conditions that qualify complexity in specific instances of decision-making: prognostic assessments, goal-oriented decisions, marked by uncertainty, legal indeterminacy, and discretion. These traits characterize both monetary policy decisions and some regulatory decisions taken within the banking union, such as the setting of minimum requirements for own funds and eligible liabilities (MREL) and the calculation of the leverage ratios of credit institutions (Livret A judgments). Irrespective of the very distinct formal-institutional legal frameworks of these two policy fields, in those conditions legality may be determined by the discretionary choices of the decision-maker. For this reason, they impact the court’s deployment of legal principles, namely proportionality and careful and impartial examination. This cross-sector comparison sheds light on the relative specificity of monetary policy, and leads to rejecting the transposition of a distinction between “high politics” and “ordinary administration” to EU law, as a means of both explaining and guiding different degrees of judicial review in conditions of complexity. The different constitutional relevance of monetary policy decisions and of “ordinary” banking supervision requires not a distinction that can rationalize judicial review, but a full consideration of the role that the law must have in supporting non-judicial accountability. judicial review of administrative discretion, complex technical and economic assessments, monetary policy, proportionality, banking union, principle of careful and impartial examination

Monetary Policy in Sudden Stop-Prone Economies

This paper proposes a parsimonious theory explaining the cyclicality of monetary policy in emerging countries in a model where access to foreign financing depends on the real exchange rate and the government lacks commitment. The discretionary monetary policy is procyclical to mitigate balance sheet effects originating from exchange rate depreciations during sudden stops. Committing to an inflation targeting regime is found to increase social welfare and reduce the frequency of financial crises despite increasing their severity. Finally, the ability to use capital controls induces a less procyclical discretionary monetary policy and delivers higher welfare gains than an inflation targeting regime. (JEL E31, E32, E44, E52, F31, F33, F38)

The effect of the rescue plans and the need for policies to increase economic growth

This paper evaluates the economic impact of discretionary fiscal and monetary actions taken in the United States during 2020 and 2021. The fiscal actions are The Coronavirus Aid, Relief, and Economic Security Act, or the “CARES” Act, passed in March 2020; The Consolidated Appropriations Act, passed in December 2020; and The American Rescue Plan Act, passed in March 2021. The paper focuses on the impact of the “economic impact payments” that underlie these fiscal actions. The paper also examines discretionary monetary policy actions taken during the same period. The overall implication is that there is a need to return to policies that increase economic growth and stability, including rules-based fiscal and monetary policy, rather than to continue with these one-time discretionary actions.

Is There an Appropriate Monetary Policy Framework to Achieve a More Equitable Income Distribution or Do Central Bank Mandates Really Matter? Interest-Rate Rules versus a Full-Employment Policy

This article focuses on monetary policy from a Post-Keynesian/Institutionalist perspective, where there are essentially two approaches to how monetary policy can be framed. On the one hand, the rules-based approach suggests that discretionary monetary policy should be abandoned in favor of central bank fixed interest-rate rules that would seek to maintain a “fair” and stable rentier income share. On the other hand, the full-employment policy approach acknowledges that discretionary monetary policy can help to achieve full employment and, by doing so, could affect both the rentier share and the wage/profit shares of national income. Thus, while fixed interest-rate policy rules focus primarily on the rentier/non-rentier income relation, thereby leaving all concerns for unemployment and the wage-profit distribution primarily to fiscal policy, a full-employment monetary policy might directly contribute, in coordination with fiscal policy, to attain higher employment levels and desirable wage shares. This article argues, based on comparative experiences between Canada and the United States in the last four decades, that a full-employment monetary policy, or a multi-goal central bank mandate, in practice would be not only more politically feasible, but also more consistent with an equitable and stable overall functional distribution of income compared to strict interest-rate policy rules

Debt Spillovers in a Monetary Union: A Novel Rationale for Central Bank Independence

Abstract Central bank independence has been championed on the grounds that it avoids political business cycles, the time-inconsistency problem of discretionary monetary policy, and political conflicts. However, after the financial crisis, central banks have resorted to unconventional monetary policies and embraced additional tasks, making monetary authorities more exposed to political interference. This new reality has put into question the long-lasting consensus on the desirability of central bank independence. We add to this debate a new argument in support of that independence, namely, it internalizes the fiscal spillovers that arise in a monetary union, which is not a full fiscal union.

Habit Persistence and Zero Lower Bound Risk under Optimal Discretionary Monetary Policy

Habit Persistence and Zero Lower Bound Risk under Optimal Discretionary Monetary Policy

Monetary Policy Risk: Rules versus Discretion

AbstractLong-run asset pricing restrictions in a macro term structure model identify discretionary monetary policy separately from a policy rule. We find that policy discretion is an important contributor to aggregate risk. In addition, discretionary easing coincides with good news about the macroeconomy in the form of lower inflation, higher output growth, and lower risk premiums on short-term nominal bonds. However, it also coincides with bad news about long-term financial conditions in the form of higher risk premiums on long-term nominal bonds. Shocks to the rule correlate with changes in the yield curve’s level. Shocks to discretion correlate with changes in its slope.

Zmiany stopy procentowej Narodowego Banku Polskiego w XXI w. na tle reguły Taylora

Głównym celem tego opracowania jest analiza zmian stopy procentowej NBP w XXI w. Jako narzędzie badawcze wykorzystano regułę Taylora, która często stanowi odniesienie do zmian krótkookresowych stóp procentowych. W wielu przypadkach, mimo relatywnej swojej prostoty, dobrze opisuje faktyczne zmiany stóp procentowych w bankach centralnych. Opracowanie składa się z trzech głównych części. W pierwszej zarysowano współczesną politykę pieniężną, dokonując próby uchwycenia jej konsensu w zakresie celów, instrumentów i strategii. Ukazano przy tym rolę reguł i dyskrecjonalności w polityce pieniężnej. W drugiej części przedstawiono metodykę badania empirycznego zastosowanego w tym opracowaniu. Wskazano główne założenia badawcze oraz omówiono konstrukcję reguły Taylora. Trzecia część artykuł zawiera badania empiryczne, w których przeprowadzono analizę zmian stopy referencyjnej NBP w XXI w. na tle reguły Taylora. Dokonano przy tym oceny wybranych decyzji dotyczących zmiany tej stopy, w szczególności w latach 2015-2020.

Sinhronizacija poslovnog ciklusa i monetarna politika u Bosni i Hercegovini

By adopting the currency board at the end of the last century, and by pegging its exchange rate to the Euro, a quarter of a century ago, Bosnia and Herzegovina surrendered a great part of its monetary policy in the hand of European Central Bank in the hope that the synchronization of the business cycle will make foreign monetary policy completely suitable for Bosnia and Herzegovina. At the same time during these two decades, the Central Bank of Bosnia and Herzegovina has been developing and using reserve requirement and remuneration as discretionary instruments of monetary policy. The research shows that the domestic business cycle and the foreign one are relatively weakly synchronized compared to other countries' degree of synchronization, and by this findings current discretionary monetary policy and its further development and enrichment with new instruments is fully justified. Bosnia and Herzegovina must continue with developing its own discretionary monetary policy without relying on foreign monetary policy.

Eksterni i interni makroekonomski šokovi u slučaju malih ekonomija sa valutnim odborom

External and internal economic shocks can threaten the macroeconomic stability of a small economy. In the currency board regime, there is no role for the Central Bank as a macroeconomic stabilizer in the event of an external or internal shock. In this paper, the research is based on the analysis of eight countries with small economies with currency boards or discretionary monetary policy. The impact and connections between changes in EURIBOR, interest rates, inflation measured by the GDP deflator, money supply and GDP in the period 1997-2015 are analyzed. The paper proves that in countries with a currency board, whose regimes have a harmonized relationship with the European Central Bank and EURIBOR, interest rate shocks are less pronounced. The analysis of the links between EURIBOR, interest rates, money supply, inflation and GDP is not statistically significant in the "experiment" countries. In the control sample of countries with a variable exchange rate, the situation is heterogeneous for individual countries, but statistical significance has been determined in relation to EURIBOR and inflation. We conclude that EURIBOR may be one of the generators of exogenous shocks. In the case of Bosnia and Herzegovina (B&H), there are much more significant internal transmission mechanisms that lead to macroeconomic imbalances. The growth of deposits was preceded by the growth of loans and money supply. This led to a fall in interest rates which the Central Bank of BiH (CBB&H) could not influence due to the currency board. However, the fall in interest rates did not yield the expected results. GDP has shrunk, inflation is falling, while at the same time the high unemployment rate has remained unchanged. The nominal exchange rate of the domestic currency was determined by law, but there was an appreciation of the real exchange rate, which affected the increase in the foreign trade imbalance. The result of the currency board is price stability, nominal exchange rate stability and money supply growth. Negative results are: appreciation of the real exchange rate, faster growth of imports and maintaining a very high unemployment rate. Macroeconomic developments in the BiH economy do not always have the right course that can be expected in mature economies. The achievements and applicability of standard macroeconomic policies are very limited.

Monetary Policy Risk: Rules vs. Discretion

Long-run asset-pricing restrictions in a macro term-structure model identify discretionary monetary policy separately from a policy rule. We find that policy discretion is an important contributor to aggregate risk. In addition, discretionary easing coincides with good news about the macroeconomy in the form of lower inflation, higher output growth, and lower risk premiums on short-term nominal bonds. However, it also coincides with bad news about long-term financial conditions in the form of higher risk premiums on long-term nominal bonds. Shocks to the rule correlate with changes in the yield curve’s level. Shocks to discretion correlate with changes in its slope.

A 100 Years of Dollar Hegemony

The essence of monetary hegemony is the power of one monetary authority to influence monetary conditions outside its jurisdiction. Such power did not exist under the gold standard but came into existence for the U.S. Federal Reserve in the aftermath of the First World War. The basis of that power was the massive drain of gold out of Europe into the U.S. during its period of neutrality and the scope for the newly created Federal Reserve to pursue a discretionary monetary policy with specific aims such as stable prices, rapid recovery from recession, and countering pullbacks in the equity market. Throughout its 100-year exercise of monetary hegemony, the U.S. has used this in ways that have spread inflation around the globe, both goods inflation and asset inflation. Both the U.S. and the rest of the world would have benefited from a U.S. monetary hegemon based on sound money principle rather than on inflationary finance.

Monetary Policy after the Great Moderation

Abstract The interferences among some financial, economic and monetary variables are checked as an indicator of economic performance in the long run and for the monetary policy applied between the Great Moderation (GM) of 1987-2001 and the Global Financial Crisis of 2007-2009. For achieving this target, some Granger causality tests are applied to GDP growth, credit growth, and lending interest of 36 countries of the EU and the OECD for the full sample of 1987-2012 and the sub-sample of 2002-2007. Results corroborate the interferences among these variables for the discretionary monetary policy applied immediately after the GM, within the “Ad Hoc Era” or “lax period”, and independence when monetary policy was correctly applied and rules-based.

U.S. Monetary Policy and Herding: Evidence from Commodity Markets

This paper investigates the presence of herding behavior across a spectrum of commodities (i.e., agricultural, energy, precious metals, and metals) futures prices obtained from Datastream. For the first time in English-language literature, this study provides an explicit investigation of the role of deviations of U.S. monetary policy decisions from a standard Taylor-type monetary rule, in driving herding behavior with respect to commodity futures prices, spanning the period 1990–2017. The results document that the commodity markets are characterized by herding. Such herding behavior is not only driven by U.S. monetary policy decisions. Such decisions exert asymmetric effects on this behavior. An additional novelty is that the results document that herding is stronger during discretionary monetary policy regimes.

Robust Monetary Policy Under Uncertainty About the Lower Bound

Abstract Central banks face uncertainty about the true location of the effective lower bound (ELB) on nominal interest rates. We model optimal discretionary monetary policy during a liquidity trap when the central bank designs policy that is robust with respect to the location of the ELB. If the central bank fears the worst-case location of the ELB, monetary conditions will be more expansionary in the period before the liquidity trap.

DOES THE PROCYCLICALITY OF CAPITAL REQUIREMENTS AFFECT FINANCIAL STABILITY IN CEMAC?

The objective of this article is to analyze the effects of procyclical variations of the capital requirements for risk coverage on financial stability in the CEMAC[1]. In order to achieve this objective, we have specified and estimated a panel VAR model using the structural factorization method on quarterly Central Bank data over the period 2006-2017. Firstly, the results show that procyclical capital adjustments in the CEMAC region lead to short-term financial instability through the contraction of credit to the private sector. Secondly, despite the low level of financial development, the effects maintained by the adjustment of monetary policy instruments in the short term remain significant on price stability. Finally, in the long term, the procyclicality of regulatory capital makes it possible to revive economic activity and guarantee financial stability. These results lead us to recommend the adoption of a more discretionary monetary policy so as to make more procyclical the capital requirement.
 
 
 [1] Economic Community of Central African States comprising Cameroon, Central African Republic, Chad, Congo, Gabon and Equatorial Guinea.

Sectoral inflation persistence and optimal monetary policy

This paper examines optimal monetary policy in a new Keynesian model with sectoral inflation persistence. It focuses on the welfare differential between timeless perspective (TP) and a purely discretionary monetary policy. Sectoral inflation persistence renders the central bank’s optimization problem more complicated under both cases of constant elasticity of substitution consumption index and generalized rule-of-thumb price setting. We find that there are substantial gains from employing a TP policy. This paper addresses the fact that this gain is robust with any changes in key structural parameters.