mishkin_194195_ppt21

Chapter 21

Monetary Policy Strategy: The International Experience

© 2006 Pearson Addison-Wesley. All rights reserved 21-2

Role of a Nominal Anchor

Ties Down Expectations

Helps Avoid Time-Consistency Problem1. Arises from pursuit of short-term goals which lead

to bad long-term outcomes

2. Time-consistency resides more in political process

3. Nominal anchor limits political pressure for time-consistency


Exchange-Rate Targeting

Advantages1. Fixes for internationally traded goods

2. Anchors expectations

3. Automatic rule, avoids time-consistency

4. Easy to understand: “sound currency” as rallying cry

5. Helps economic integration

6. Successful in reducing

France, UK, Mexico


Exchange-Rate Targeting

Disadvantages1. Loss of independent monetary policy

Problems after German reunification: UK, French monetary policy too tight

2. Open to speculative attacksEurope, Sept. 1992; Mexico: 1994; Asia: 1997

3. Successful speculative attack disastrous for emerging market countries because it leads to financial crisis

4. Weakened accountability: lose exchange-rate signal

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Currency Boards vs. Dollarization

Currency Boards1. Domestic currency exchanged at fixed rate for foreign currency

automatically2. Fixed exchange rate with very strong commitment mechanism

and no discretion3. Usual disadvantages of fixed exchange rate4. Still subject to speculative attack5. Lose ability to have lender of last resort

Dollarization1. Even stronger commitment mechanism2. No possibility of speculative attack3. Usual disadvantages of fixed exchange rtae4. Lose seignorage


Summary: Advantages and Disadvantages of Different Monetary Policy Strategies

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Monetary TargetingCanada

1. Targets M1 till 1982, then abandons it2. 1988: declining targets, M2 as guide

United Kingdom1. Targets M3 and later M02. Problems of M as monetary indicator

Japan1. Forecasts M2 + CDs2. Innovation and deregulation makes less useful as monetary

indicator3. High money growth 1987-1989: “bubble economy,” then tight money

policyGermany and Switzerland

1. Not monetarist rigid rule2. Targets using M0 and M3: changes over time3. Allows growth outside target for 2-3 years, but then reverses

overshoots4. Key elements: flexibility, transparency, and accountability


Monetary Targeting

Advantages1. Able to cope with domestic considerations2. Signals are immediate3. Immediate accountability of central bank

Disadvantages1. Big if: all advantages require reliable relationship

between goal and targeted aggregate2. In many countries, weak relationship between

goal and M-aggregatePoor communications device and accountability


Inflation Targeting

Five Elements1. Public announcement of medium-term -

target

2. Institutional commitment to price stability

3. Information inclusive strategy

4. Increased transparency through public communication

5. Increased accountability

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Inflation Targeting in New Zealand, Canada, and the UK


Inflation Targeting

Advantages1. Allows focus on domestic considerations

2. Not dependent on reliable relationship between M-aggregate and inflation

3. Readily understood by public

4. Reduce political pressures for time-consistent policy

5. Focus on transparency and communication

6. Increased accountability of central bank

7. Performance good: and e , and stays low in business cycle upturn


Inflation Targeting

Disadvantages1. Delayed signalling2. Too much rigidity3. Potential for increased output fluctuations4. Low economic growth

Nominal GDP Targeting1. Close to inflation targeting with concern about

output fluctuations2. Problem of announcing specific target for real

GDP growth3. Harder for public to understand


Monetary Policy with an Implicit Nominal Anchor

Forward-Looking and Preemptive to Deal With Long Lags

Advantages1. Focus on domestic considerations

2. Has worked very well in the U.S.

3. If It Ain’t Broke Why Fix It?

Disadvantages1. Lack of transparency and accountability

2. Dependence on personalities

3. Inconsistent with democratic principles

mishkin_194195_ppt21

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