Stable Price Level Research Articles

Too Sensational: On the Choice of Exchange Rate Regimes

Too Sensational: On the Choice of Exchange Rate Regimes By W. Max Corden. Cambridge, MA: MIT Press. 2002. Pp. xiv, 274. $29.95.This volume is the 10th in the series of Ohlin lectures initiated in 1988 at the Stockholm School of Economics. This volume, like the others (the first of which was Bhagwati's 1988 lively Protectionism) is characterized by clear and imaginative thought with no equations. Corden describes his method as story telling informed by theory (p. xiii). The jacket of Bhagwati's book was a cartoon from Punch, which showed the British Prime Minister being led to free trade. My choice for the jacket of this book would have been something like The Economist's November 28, 1968, cover, which showed the heads of Charles DeGaulle, Richard Nixon, and Harold Wilson bobbing among the waves, with the caption It's much better to float. That is the message of the book for most countries: floating is better than a fixed-but-adjustable exchange rate regime, or a FBAR, to use Corden's abbreviation.Instead, the jacket of the book displays the quote from Oscar Wilde's The Importance of Being Earnest that introduced one of the chapters in an early edition of Samuelson's textbook. Cecily, you will read your Political Economy in my absence. The chapter on the Fall of the Rupee you may omit. It is somewhat sensational. Even these metallic problems have their melodramatic side. Since my introductory course in economics, I had wondered about what that quote meant. Now 42 years later, I discover that the rupee had been pegged to silver, the pound to gold, and when the price of silver plummeted in the 1870s, the rupee depreciated. Indian goods became more competitive, creating competitiveness problems for British industry, and the home charges, which India had to take to Britain, were denominated in sterling, creating fiscal problems for India. Corden notes that the more recent FBARs have also been too sensational (p. x). This is his way of saying it is important to keep exchange rates in line with fundamentals, or It's much better to float.Corden credits Ohlin with seeing clearly in 1931 the importance of adjusting the Swedish Kroner in order to stabilize the Swedish price level, yet another contribution in addition to his ideas on the factor price equalization theorem and the transfer problem, and his service as leader of Sweden's liberal party for 34 years. Corden quotes Keynes in 1923 as favoring price level stability as more important than exchange rate stability and believing that the most cogent rationale for a gold standard was the rather weak discipline argument, strapping down Ministers of Finance (p. 13).Corden reminds us of core ideas about exchange rate regimes. For example, there is Milton Friedman's point that there is a presumption that currency speculation will be stabilizing, for destabilizing speculation is unprofitable. He laments the jerkyness of FBARs. He suggests that either flexible nominal wages or inflexible real wages creates an overwhelming case for an absolutely fixed (exchange rate) regime. In the former case, exchange rate change is not needed to maintain competitiveness, and in the latter it is not useful. A peg to an individual currency is preferable to pegging to a currency basket in that the former saves transaction costs and is easier to monitor. What follows is a collection of Corden's insights that 1 found particularly interesting.Not many economists living in the real world would dispute that in the short run there is some degree of sluggishness downward of nominal wages in most, if not all, countries (p. 89). And based on overwhelming empirical evidence, Keynesian analysis and policies as presented here are still appropriate for short-to-medium-term situations (p. 90). Also, the Barro-Ricardo complication that forward-looking tax payers will offset fiscal actions is only partial at best, leaving Keynesian demandside prescriptions in tact. …

Indirect convertibility as a money rule for inflation targeting

In this paper we re-examine the case for Indirect Convertibility made by Greenfield and Yeager (1983, 1989) as a mechanism for promoting greater internal price level stability. We argue that with some reinterpretation, indirect convertibility can be interpreted as a convenient, practical monetary policy rule by which central banks engaged in inflation targeting can better achieve their price stabilization goals. It also implies that the more general acceptance of indirect convertibility by a set of countries pursuing a common inflation target would better coordinate group success and by doing so could form an important intermediate step in coordinating the adoption of a common currency

Stabilizing properties of monetary feedback rules: A representative-agent approach

Evidence from theoretical models fails to support the obvious preference that many stabilization-policy advocates have for monetary policies that feature negative feedback over those that feature positive feedback. In this paper, I employ a representative-agent model to investigate the stabilizing properties of positive- and negative-feedback monetary policy rules. I consider two alternative policy objectives—price-level stabilization and inflation-rate stabilization—along with two alternative versions of the agent's intertemporal allocation problem. None of the results supports the notion that negative-feedback policies are more likely than positive-feedback policies to be successful in stabilizing the price level or the inflation rate.

Price Level Stability: Some Issues

This article challenges the conventional wisdom that price level targeting necessarily increases the volatility of inflation and economic activity. It shows that the optimal policy under commitment for a society that cares only about the variability of output and inflation involves only a limited degree of base drift. The result crucially depends on the importance of forward-looking behaviour and on the credibility of the commitments. The case for price level targeting is strengthened when the possibility of a binding lower bound on nominal interest rates is considered. This may be increasingly relevant in a low inflation environment. This justifies renewed interest on price level targets in the context of thinking through how to prevent and respond to deflationary risks.

Monetary and Fiscal Policy in Europe: an Overview

There are new monetary and fiscal frameworks in place for the countries in the Euro Area. The European Central Bank has a remit to maintain price level stability in the medium term, and it has developed a two pillar strategy, with interest rates being set in relation to a reference value of M3 and general (inflationary) conditions. We discuss an ideal type representation of this framework and examine the potential effects of a fall in the euro. Fiscal policy in Europe is now based on guidelines from the Stability and Growth Pact and we discuss the role of commitment in this framework as well

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.

How do broader monetary aggregates and divisia measures of money perform in McCallum’s adaptive monetary rule?

This paper addresses two questions. First, can a monetary policy rule be identified that; (1) promotes greater levels of price stability than actual discretionary policy has, (2) performs well (i.e., promotes long-run price stability) in different, plausible macroeconomic models, (3) performs well when financial innovations, regulatory changes or other factors alter the relationship (e.g., velocity) between the policy instrument and the target variable, (4) when relevant, performs well when financial innovations, regulatory changes, or other factors alter the relationship between the control variable and the policy instrument, (5) allows the public to monitor central bank compliance with the rule, and (6) is operational? Second, can adaptive rules using broader Divisia measures of money as policy instruments (e.g., M2 and above) achieve greater levels of price stability than rules using the traditional monetary aggregates? Divisia measures of money are examined because research suggests they may exhibit a stronger and more stable relationship with nominal GDP than broad monetary aggregates computed as the unweighted sum of their component assets. Rules that indirectly target a stable price level are examined using the traditional aggregates and Divisia measures of M2, M3, and Liquidity (L), respectively, as policy instruments. Counterfactual GDP simulations are conducted in three different macroeconomic models over the time period 1964:Q2–1997:Q4. The performance of rules using the different policy instruments is assessed by comparing the simulated GDP time path to a target time path consistent with long-run price stability. All simulations explicitly assume that the Fed cannot precisely control the policy instruments over time periods as short as one quarter. Results suggest that all the policy instruments examined satisfy the six criteria for rule success. The best performance is produced by the rule using Divisia L as its policy instrument. Rules using Divisia measures of money usually outperform their (traditional) monetary aggregate counterparts—although the difference is often inconsequential.

Bank Reserve's Setting for Minimizing the Price Fluctuations: Taiwan's Case Studies

This paper presents a stochastic financial model from which one can derive the optimal reserves ratio for stabilizing price level. It is shown that the optimal reserves ratio is a function of the structure of unanticipated shocks to liquid asset market and high-powered money market. An important policy implication, drawn from my model, suggests that it may help for the stabilization of price level if a lower level of the reserve requirements was adopted by the central bank when the shock exists solely in liquid asset market. An application of the presented model to the financial assets in Taiwan suggests that the optimal reserves ratio for stabilizing price level is approximately 5.7717 per cent in the case of the 2-SLS estimation, and 4.2442 per cent in the case of the SUR estimation, below the weighted average of actual 7.7575 per cent up to the end of 1997. The empirical findings further suggest Taiwan's monetary authority would thus have to accept a lower level of the reserve requirements in order to reduce the price fluctuations.

Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability

This paper discusses how price stability can be defined and how price stability can be maintained in practice. Some lessons for the Eurosystem are also considered. With regard to defining price stability, the choice between price-level stability and low (including zero) inflation and the decisions about the price index, the quantitative target and the role of output stabilization are examined. With regard to maintaining price stability, three main alternatives are considered, namely a commitment to a simple instrument (like a Taylor Rule), (like inflation-forecast targeting) and intermediate (like money-growth targeting). A simple instrument rule does not provide a substitute for a systematic framework for monetary policy decisions. Such a framework is instead provided by forecast targeting. Forecast targeting can incorporate judgemental adjustments, extra-model information, and different indicators (including indicators of risks to price stability). By extending mean forecast targeting to distribution forecast targeting, nonlinearity, nonadditive uncertainty and model uncertainty can be incorporated. Eurosystem arguments in favor of its money-growth indicator and against inflation-forecast targeting are scrutinized and found unconvincing.

Pioneering price level targeting: The Swedish experience 1931–1937

In September 1931, Sweden became the first country to make the stabilization of the domestic price level the official goal of its monetary policy, actually the only country that so far has adopted such an explicit price level target. Starting from the issues and concepts familiar from research and policy experience of inflation targeting – as contrasted to price level targeting – this paper examines the evolution of the Swedish price level targeting in the 1930s. We bring out a number of similarities and differences between price stabilization in the 1930s and in the 1990s.

Real Balances, the Price Level and the Unit of Account

Abstract It is argued that Patinkin's introduction in his 1956 book of the stability analysis of the price level resulted in great measure from his reading of Wicksell's 1898 Interest and Prices. Both Patinkin and Wicksell based their treatments of the stability of the price level on what Patinkin used to call the “real balance effect.” That effect, however, does not operate under Wicksell's assumption of a competitive “pure credit economy”, where all transactions are carried out by bookkeeping transfers, and the unit of account is the same unit in which the accounts of banks are kept. In that case, Patinkin showed in the second (1965) edition of his book that the real balance effect–and, by that, the stability of the price level–would still be a feature of the system if profit maximizer banks held reserves, created by the central bank to settle temporary imbalances at the clearinghouse. According to Wicksell, on the other hand, a pure credit economy should consist of a central bank that attracts and remunerates deposits at the same interest rate charged for its loans, plus profit maximizer financial intermediaries that lend money for risky projects. The basic rate of interest set by the central bank decides, accordingly, the price level in such an economy. Wicksell's and Patinkin's approaches differ from the view put forward in the 1980s by the so‐called “new monetary economics” that the key to price level stabilization is the separation of the function of money as the unit of account from its function as the medium of exchange in pure accounting systems of exchange.

Hayek's Monetary Theory and Policy: A Critical Reconstruction

Friedrich A. Hayek's critique of price level stabilization was based on the theoretical claim that only a constant money stock (M), or constant volume of nominal spending (MV), allows intertemporal price equilibrium. The claim is not generally correct. Hayek's case (in principle) for constant MV, and his critique of the automatic gold standard for not delivering it, are thus uncompelling. The injection effects of his business cycle theory provided a sounder basis for his prescription. In the 1970s, Hayek switched to endorsing price-level stabilization. In doing so he was logically compelled to repudiate his business cycle theory.

Monetary Policy in the Transition to a Zero Federal Deficit

In the United States, eradication of persistent federal deficits has won broad bipartisan support. At the same time, political pressures have mounted to strengthen the Federal Reserve's explicit concern with price stability. Proposals under consideration would require a much narrower focus on the part of Fed policymakers, and could be interpreted as targeting the price level rather than a negligible rate of inflation. The deficit-reduction and price-stability policies should be analysed in combination, as reductions in the real interest rate triggered by lower deficits will have an impact on optimal monetary policy with anti-inflation and stabilization objectives. This paper builds upon the analysis of Orphanides and Wilcox (1996) to evaluate optimal anti-inflation policy under a broader set of circumstances than considered in their work. We consider a monetary authority with two instruments--the funds rate (or rate of base money growth) and the discount rate--with the distinction that only movements of the latter are 'credible' alterations of the Fed's policy stance, reflecting reputational effects. The public forms expectations of inflation given realized inflation and the expected progress toward lower inflation, as evidenced by credible policy moves and the gradual eradication of the fiscal deficit. The interaction between deficit reduction policy and the optimal monetary trajectory is analysed, and the implications for the coordination of these strategies considered via stochastic simulations of the model. The impacts of a price level stabilization target on the Fed and a balanced-budget rule on the fiscal authorities are contrasted with their more flexible counterparts: an inflation target and restriction on deficit spending. Our results indicate that these more stringent political constraints on economic policy could have severe consequences on the ability of the monetary and fiscal authorities to mitigate adverse economic shocks.

The Costs and Benefits of Price Stability: An Assessment of Howitt's Rule

A common objection to making price stability the primary objective of monetary policy is that, once inflation is under way, it is less costly to live with a little inflation that it is to achieve a stable price level (as proposed in Howitt’s Rule). The author assesses the conditions that Howitt’s Rule requires and shows how reduced output growth caused by inflation might dramatically affect the outcome.

The persistence of bimetallism in nineteenth-century France

the establishment of a fixed nominal anchor as the key characteristic of commodity money standards.2 That is, while under a fiat money standard the nominal money supplies-and hence to varying degrees nominal exchange rates, interest rates, and prices-are determined by human forces, it is argued that under a commodity money standard nominal exchange rates were fixed and other nominal magnitudes were only to a limited extent subject to design. Yet this is actually a characterization of the classical gold standard, rather than of all commodity money regimes; and although commodity money standards have been widespread for almost a thousand years, bimetallism rather than monometallism has been the rule. The former, unlike the latter, did not provide a fixed nominal anchor since changes in the relative market price of gold and silver invariably led to a reduction in the specie backing of the unit of account.3 Why was the gold standard so late in coming? I argue here that the choice of bimetallism over monometallism did not reflect a disregard for the benefits of a fixed standard of value, or even a belief that bimetallism generated greater price level stability, but rather it reflected the inability of a monometallic standard to provide conveniently sized coins for both high and low denominations. This perspective suggests that the adoption of the gold standard reflected a significant change in monetary technology that resolved the commodity money dilemma, and permitted a monometallic standard to offer an array of different values of coin. Such an explanation is in sharp contrast to existing explanations for the origins of the gold standard. These traditional views argue that Britain 'accidentally' went on the gold standard in i8i6 and that Britain's economic

Interest rate policy of the deutsche bundesbank: An econometric analysis for 1975 to 1992

Internal and external economic targets which a monetary authority tries to achieve make its interest rate policy partly endogenous. This article analyses the Bundesbank's interest rate policy since 1975, the year the Bundesbank published its first intermediate money growth target based on estimates of an ‘inevitable’ inflation rate and expectations about economic development. Estimation of a discount rate reaction function suggests that German monetary policy responds primarily to the final objective of price level stability and to a smaller extent, to the intermediate money supply target. Moreover, cyclical movements and balance-of payments equilibria are found to significantly influence the Bundesbank's discount rate policy. Both the inflation rate and the current account enter the reaction function in a non-linear way. When inflation is above the targeted rate or when there is a current account deficit, discount rate responses are much stronger than in the case of ‘below target’ inflation or a current account surplus. Internationally, the Bundesbank discount rate policy is limited by US short-term interest rate movements.

The case for a “productivity norm”: Comment on Dowd

Instead of aiming for zero inflation, a “productivity norm” would allow permanent changes in the price level reflecting opposite changes in productivity or unit costs of production. Dowd (1995) disputes my claim that a productivity norm would be more conducive to macroeconomic stability than a stable price level. But Dowd's arguments succeed in undermining the case for a productivity norm only to the extent that they also undermine his own case for zero inflation.

Deflating the productivity norm

This paper offers a critical appraisal of the “productivity norm,” according to which the price level should fall in line with improvements in productivity, and compares it with the more popular alternative of price-level stability. Among the problems with the productivity norm are that it would make the price level uncertain, it would discourage productivity growth, and it would increase the costs of adjusting prices. The paper is also skeptical of claims that the productivity norm would make real output more stable than it would be under price stability.

Stabilizing Inflation in the Open Economy

Optimal monetary policy in the open economy continues to be of interest to the profession, as in Benavie and Froyen [1], and price level stabilization has been investigated by Bradley and Jansen [4], Marquis and Cunningham [13], and Fischer [6], among many others. Price level stabilization has also been investigated in the monetary policy literature by, for example, Black [2] or Black and Gavin [3]. The academic literature has included analysis of price level stabilization in a variety of macroeconomic frameworks ranging from overlapping generations models to equilibrium business cycle models and Keynesian contracting models. What has been lacking, however, is a rigorous analysis of price level stabilization in the open economy. This apparent omission is interesting because the most famous historical application of price level targeting occurred in the 1930s in Sweden a small open economy.' In this paper we carefully examine the effectiveness of price level or inflation stabilization in the small open economy.2 Employing an equilibrium business cycle model with differentially informed agents, we find that when shocks to the economy exhibit some persistence, inflation stabilization has favorable output stabilization properties relative to alternative monetary policies. Further, these beneficial aspects of inflation stabilization exist whether or not agents contemporaneously observe the money stock. The only instance in which inflation stabilization policy is not preferred is when all shocks to the economy are strictly temporary shocks and when uninformed agents can not observe the money stock contemporaneously. Finally, in all instances we find that price level stabilization is preferred, from a macroeconomic stabilization perspective, to exchange

Money, Banking and Inflation: Essays in the History of Monetary Thought

Money, Banking and Inflation focuses on such traditional central banking concerns as money stock control, price level stabilization, interest rates smoothing, exchange rate targeting, lender-of-last-resort responsibilities, limitations imposed by short-run tradeoffs and non-neutralities, and appropriate responses to supply shocks. Virtually all the essays take an historical-doctrinal perspective which, besides showing how these theories developed over time, allows them to be ranked according to their effectiveness in monetary controversies old and new.