Monetary Policy Stability Research Articles

Optimal Degrees of Transparency in Monetary Policymaking

According to most academics and policymakers, transparency in monetary policymaking is good for society. I examine this proposition in a small theoretical model where more transparency makes it easier for price setters to infer the central bank's true policy intentions. This induces the central bank to pay relatively much attention to inflation stabilization. In contrast with popular perceptions and most existing literature, I find that transparency need not always be advantageous. It may actually be a policy distorting straitjacket if the central bank enjoys good initial credibility, and there is need for active monetary stabilization policy.

Optimal Monetary and Fiscal Policy: A Linear-Quadratic Approach

We propose an integrated treatment of the problems of optimal monetary and fiscal policy for an economy in which prices are sticky (so that the supply-side effects of tax changes are more complex than in standard fiscal analyses) and the only available sources of government revenue are distorting taxes (so that the fiscal consequences of monetary policy must be considered alongside the usual stabilization objectives). Our linear-quadratic approach allows us to nest both conventional analyses of optimal monetary stabilization policy and analyses of optimal tax-smoothing as special cases of our more general framework. We show how a linear-quadratic policy problem can be derived which yields a correct linear approximation to the optimal policy rules from the point of view of the maximization of expected discounted utility in a dynamic stochastic general-equilibrium model. Finally, in addition to characterizing the optimal dynamic responses to shocks under an optimal policy, we derive policy rules through which the monetary and fiscal authorities may implement the optimal equilibrium. These rules take the form of optimal targeting rules, specifying an appropriate target criterion for each authority.

Optimal Degrees of Transparency in Monetary Policymaking

According to most academics and policymakers, transparency in monetary policymaking is desirable. I examine this proposition in a small theoretical model emphasizing forward–looking private sector behavior. Transparency makes it easier for price setters to infer the central bank’s future policy intentions, thereby making current inflation more responsive to policy actions. This induces the central bank to pay more attention to inflation rather than output gap stabilization. Then, transparency may be disadvantageous. It may actually be a policy–distorting straitjacket if the central bank enjoys low–inflation credibility, and there is need for active monetary stabilization policy. JEL classification: E42; E52; F58

Global Implications of Self-Oriented National Monetary Rules

Author(s): Obstfeld, Maurice; Rogoff, Kenneth | Abstract: It is well known that if international linkages are relatively small, the potential gains to international monetary policy coordination are typically quite limited. But what if goods and financial markets are tightly linked? Is it then problematic if countries unilaterally design their institutions for monetary stabilization? Are the stabilization gains from having separate currencies largely squandered in the absence of effective international monetary coordination? We argue that under plausible assumptions the answer is no. Unless risk aversion is very high, lack of coordination in rule setting is a second-order problem compared to the overall gains from monetary policy stabilization.

Endogenous Exchange Rate Pass-Through when Nominal Prices are Set in Advance

This paper develops a model of endogenous exchange rate pass-through within an open economy macroeconomic framework, where both pass-through and the exchange rate are simultaneously determined, and interact with one another. Pass-through is endogenous because firms choose the currency in which they set their export prices. There is a unique equilibrium rate of pass-through under the condition that exchange rate volatility rises as the degree of pass-through falls. We show that the relationship between exchange rate volatility and economic structure may be substantially affected by the presence of endogenous pass-through. Our key results show that pass-through is related to the relative stability of monetary policy. Countries with relatively low volatility of money growth will have relatively low rates of exchange rate pass-through, while countries with relatively high volatility of money growth will have relatively high pass-through rates.

GLOBAL STABILITY OF INFLATION TARGET POLICIES WITH ADAPTIVE AGENTS

We study a dynamic equilibrium model in which agents have adaptive expectations and monetary authorities pursue an inflation target. We show how alternative monetary stabilization policies become more effective when fiscal constraints on deficits are implemented, although they are not binding at the equilibrium target. In particular, we show that the inflation target equilibrium can be locally, or even globally, stable for a large class of adaptive learning schemes. We also compare alternative stabilization policies in terms of their stability properties. Commonly postulated conditional Taylor-type rules tend to be dominated by other rules, such as an unconditional Friedman type.

Optimal Degrees of Transparency in Monetary Policymaking

According to most academics and policymakers, transparency in monetary policymaking is desirable. I examine this proposition in a small theoretical model emphasizing forwardlooking private sector behavior. Transparency makes it easier for price setters to infer the central bank's future policy intentions, thereby making current inflation more responsive to policy actions. This induces the central bank to pay more attention to inflation rather than output gap stabilization. Then, transparency may be disadvantageous. It may actually be a policy-distorting straitjacket if the central bank enjoys low-inflation credibility, and there is need for active monetary stabilization policy.

PRICE DETERMINATION AND STABILIZATION UNDER FREE BANKING SYSTEM

In the past the long run objective of monetary policy was a balanced budget, but more recently it has focussed on price stability. Price level stabilization had many proponents during the 1920s and 1930s and continues to have advocates today. The central banks of the US, New Zealand, Germany, and others espoused it during the last two decades. Price level determination and hence stabilization are important issues for economies since they determine the expectations of policy makers and individuals. Price level stability implies a steady inflation rate; it is similar to zero inflation but it differs in that price level stability returns the price level to its initial level while zero inflation implies offsetting a rise in prices and aims to stop future price rises. Price level stability is the better objective for monetary policy since private individuals desire a stable and predictable monetary environment to engage in business transactions. Therefore, the price level will be more predictable under a stable price objective than under zero inflation one. This also brings long run price stability, because of a stable monetary policy. The paper covers several classical views of price level stability and stabilization: how price level is theoretically and historically determined and stabilized under free banking and central banking regimes, as well. Consequently, empirical evidence concerning the price level stability under free banking is mixed.

The Value of Waiting: Russia's Integration into the International Capital Markets

Capital flight has characterized Russia's integration into international capital markets. Inflows of foreign direct investment have been minor and preceded by temporary inflows of portfolio capital. The paper shows that uncertainty about macroeconomic stabilization exerts a strong negative effect on the volume of capital inflows when investment decisions are irreversible. Reducing uncertainty may, but need not necessarily, lead to more investment if institutional reforms fail to lower the degree of irreversibility. Since monetary stabilization policies have not been accompanied by comprehensive institutional reforms, private capital flows in Russia have remained low and foreign direct investment has been particularly harmed.J. Comp. Econom., June 1999, 27(2), pp. 209–230. The Kiel Institute of World Economics, 24105 Kiel, Germany.

Russian monetary policy – assessing the track record

Since early 1995, monetary stabilization has gradually been achieved in Russia. Extremely high real interest rate have been maintained throughout autumn 1996, an exchange rate target has been adhered to since mid-1995, auctions of Central Bank credit have gained in importance, and subsidized lending has been cut down. However, the conduct of monetary policy remains a trial-and-error process: Indirect budget financing through the CBR still occurs, the fixed exchange rate regime has caused a lack of control over the monetary base, and the money multiplier is relatively unstable. Preliminary empirical evidence shows that money demand has remained relatively stable since the beginning of reforms. Still, short-run fluctuations of money demand are substantial, and further portfolio adjustments are likely if inflationary expectations decline and if the capital account becomes more open. The success of monetary stabilization crucially depends on the effectiveness with which the CBR can defend its independence. Because financial sector stability is an important condition for a predictable and stable monetary policy, further measures to restructure and to consolidate the banking sector need to be pursued in parallel to structural reforms of the Russian economy.

Can Monetary Stabilization Policy be Improved by CPI Futures Targeting?

Scott Sumner (and similarly Kevin Dowd) proposes to have the central bank write futures contracts on the Consumer Price Index, and automatically adjust the money stock in response to the public's net position in such contracts, as a way of improving the precision and credibility of monetary policy. The authors identify two serious problems that can be expected to render Sumner's proposal ineffective: (1) the public has no incentive to take a speculative position in the contracts until it is too late to adjust the money stock and (2) the central bank lacks an effective budget constraint. Copyright 1997 by Ohio State University Press.

Monetary targeting in Germany: The stability of monetary policy and of the monetary system

For more than two decades the Deutsche Bundesbank has followed a strategy of pre-announcing targets for the growth in broad money. Such consistency has not conflicted with limited flexibility in policy implementation. The stable policy environment may have contributed to the stability of the monetary system in general and money demand in particular, thus facilitating the maintenance of the strategy.

Does a constant money growth rule help stabilize inflation?: experimental evidence

We design and study the behavior of experimental overlapping generations economies in which the government either finances real deficits through seigniorage or allows money supply to grow at a predetermined rate. We provide experimental data to study the conjecture that a “simple” rule, such as a constantgrowthofthemoneysupply, can help coordinate agents' beliefs and help stabilize the economy. Our experimental data provide weak evidence for such a conjecture. The underlying stability parameters of the economy provide a better explanation of observed price volatility than differences in the policy do. In particular, in relatively unstable environments, subjects base their forecasts more on observed fluctuations than on the announcements of stable monetary policies.

Does a constant money growth rule help stabilize inflation?: experimental evidence

Abstract We design and study the behavior of experimental overlapping generations economies in which the government either finances real deficits through seigniorage or allows money supply to grow at a predetermined rate. We provide experimental data to study the conjecture that a “simple” rule, such as a constant growth of the money supply, can help coordinate agents' beliefs and help stabilize the economy. Our experimental data provide weak evidence for such a conjecture. The underlying stability parameters of the economy provide a better explanation of observed price volatility than differences in the policy do. In particular, in relatively unstable environments, subjects base their forecasts more on observed fluctuations than on the announcements of stable monetary policies.

Stagflation and Monetary Stabilization Policies: A Rejoinder

Stagflation and Monetary Stabilization Policies: A Rejoinder

Stagflation and Monetary Stabilization Policies: A Comment

Stagflation and Monetary Stabilization Policies: A Comment

COUNTING THE COST OF HIGHER BASE RATES

It is a brave Chancellor of the Exchequer who raises interest rates when inflation is at record low levels and there are few signs of overheating. But Kenneth Clarke is clearly trying to give substance to his commitment ‐ made in June's Mansion House Speech ‐ to pursue stable monetary and fiscal policies. In that speech, the Chancellor told his City audience that the government had “not created the conditions for the strongest recovery in Europe in order to throw it away by creating yet another boom followed by bust”.There is widespread agreement with the Chancellor's objectives. But the difficult question for economic management is how high interest rates will need to go in order to contain inflation and keep the economy on course. In this Forecast Release, we examine this question as well as assessing the likely impact of the first rise in base rates for five years.

Central bank constitutions for federal monetary unions

In a monetary union the central bank constitution must distribute the power over monetary policy between the members and the administrative center of the union. We compare alternative distributions and evaluate their performance. Dominance of regional interests always leads to inefficient monetary stabilization policies. Whether or not dominance of regional interests leads to a higher long-run rate of inflation depends on the union's political constitution.

Uncertainty in interdependent economies with monopoly unions

We demonstrate that cooperative monetary stabilization policies need not be advantageous when interdependent economies are subject to symmetric shocks. In comparison with non-cooperative policies, inflation becomes more uncertain under cooperation. When unions hedge against more inflation uncertainty by raising wage demands, average employment (inflation) decreases (increases). Such stagflationary properties are therefore most likely to materialize when policies are performed cooperatively.

Limited capital markets and the real effects of monetary stabilization policies under alternative exchange rate regimes

A common argument against monetary stabilization policies in developing countries is that they lead to short-run output contractions. This paper argues that, in economies facing severely limited capital markets, such contractionary effects may hold only under a fixed exchange rate system, especially if the policy lacks credibility. However, if currency substition is an additional feature of the economy, monetary deceleration may be expansionary even under fixed exchange rates. (JEL E52, E63)