Reserve requirements,currency substitution,and seigniorage in the transition to European monetary union

This article considers a transition toward European monetary union that combines increased substitution of currencies and greater monetary, financial, and fiscal policy coordination. It explores how such a transition would affect national inflation and interest rates and required reserve ratios when governments depend in part on seigniorage funding for public expenditures. We find that greater coordination of policies would lead to lower inflation and interest rates but higher reserve-requirement ratios. Because higher reserve-requirement ratios could place European banks at a competititve disadvantage, we conclude that the interaction between reserve requirements and seigniorage concerns makes it less likely that the gradualist approach of the Maastricht treaty is a sustainable means of transition to European union.     

Debt targets and fiscal sustainability in an era of monetary independence

This paper investigates how to achieve flexibility in fiscal policy without sacrificing credibility or independence in monetary policy. The idea is to create a framework that generates fewer conflicts between policies but greater discipline within them. We assume an independent central bank and restraints on national fiscal policies. Using a theoretical model, we examine the consequences of assigning leadership to fiscal policies in order to exploit the implicit (but rule based) coordination available under standard transmission mechanisms and to allow priorities and targets to differ between policy makers. This works best when leadership takes the form of a debt rule (with hard or soft targets) to precommit fiscal policies over the longer term; but monetary independence to guarantee the credibility and discipline in the short term policies. Compared to the uncoordinated policies operating in Europe, inflation biases and debt/deficit ratios are both lower for no loss in output volatility. That matches the experience of the UK, an economy whose empirical reaction functions show fiscal leadership. On a wider sample of Organization for Economic Cooperation and Development countries, the gains from debt targeting are estimated at 2–4% of gross domestic product.     

Macroeconomic stabilization through monetary and fiscal policy coordination: Implications for European Monetary Union

In a two-country model, we consider the implications of monetary and fiscal policy coordination for macroeconomic stabilization. We show that the optimal regime is one of monetary and fiscal policy coordination under flexible exchange rates. In the context of the European Community, this suggests that the desire to fix exchange rates may not be costless. In addition, we show that fiscal coordination requires a relatively high degree of flexibility in fiscal policy. This result suggests that limits on the flexibility of fiscal policies, as suggested in the Delors Report, may hinder macroeconomic stabilization.     

A Macroeconomic Policy Game for a Monetary Union with Adaptive Expectations

We consider a dynamic game model of a two-country monetary union. Governments (fiscal policies) pursue national goals while the common central bank’s monetary policy aims at union-wide objectives. For a symmetric demand shock, we derive numerical solutions of the dynamic game between the governments and the central bank. We consider conflicting (non-cooperative Nash equilibrium) and coordinated policy-making (cooperative Pareto solutions). We show that there is a trade-off between the deviations of instruments and targets from desired paths; the volatility of output and inflation increases when private agents react more strongly to changes in actual inflation.     

Mix of Fiscal and Monetary Policy Rules and Inflation Dynamics in China

The present paper examines the role of the mix of fiscal and monetary policy rules in determining inflation dynamics using fiscal and monetary policy reaction functions and Markov‐switching vector autoregression methods based on quarterly data in the period 1992–2007. Our results show that fiscal and monetary policies in China can be adequately described using some simple rules, and that significant regime shifts took place around 1998. Fiscal policy tended to be active and countercyclical in the pre‐1998 period, then switched to be passive and more countercyclical, whereas monetary policy was characterized as passive and procyclical in the pre‐1998 period, and switched to be active and countercyclical afterwards. The mix of fiscal and monetary policy rules can explain inflation dynamics better than the monetary policy rule alone. Therefore, price stability requires not only appropriate monetary policy but also appropriate fiscal policy.     

Uncertainty and Fiscal Policy in an Asymmetric Monetary Union

We examine monetary and fiscal interactions in a monetary union model with uncertainty due to imperfect central bank transparency. It is first shown that monetary uncertainty discourages excessive taxation and may thus reduce average inflation and output distortions. However, as countries enter the monetary union, this tax-restraining effect of uncertainty is mitigated. The monetary union may hence lead to higher fiscal distortions in some member countries, depending on governments’ spending targets and on the change in the degree of uncertainty implied by common monetary policy.     

The role of credibility in the cyclical properties of macroeconomic policies in emerging economies

Optimal stabilization policy is countercyclical, aiming at keeping output close to its potential. However it has been traditionally argued that emerging countries are unable to adopt countercyclical monetary and fiscal policies. Here we argue that the cyclical properties of macroeconomic policies depend critically on policy credibility. We test this proposition by making use of recent panel data for eleven emerging market economies and time series data for Chile. The evidence supports that countries with higher credibility, as reflected by lower country risk levels, are able to conduct countercyclical fiscal and monetary policies. Conversely, countries with less credible policies (and, therefore, with higher country risk spreads) contribute to larger cyclical fluctuations by applying procyclical policies. For Chile we find that both monetary and fiscal policies have been largely countercyclical after 1993. JEL no. E43, E52, E62     

东南亚应对通货膨胀的经验与启示

面对2007年下半年以来不断恶化的通货膨胀形势,东南亚主要经济体积极运用市场干预政策、财政政策、货币政策等多种政策协调配合应对通货膨胀。短期内,东南亚的通货膨胀取决于国际大宗商品价格能否企稳和其国内政策能否稳定通货膨胀预期;长期内,则取决于社会生产技术发展水平和其企业对上游产品价格上涨的消化吸收能力。东南亚应对通货膨胀的经验与教训值得我们关注。     

Monetary Aggregates Targeting,Inflation Targeting and Inflation Stabilization in Ghana

The central bank of Ghana (BoG) has operated monetary aggregates targeting and inflation targeting since the 1980s, to ensure enhanced output growth, low unemployment and stable, low inflation. Under inflation targeting, the inflation rate averaged 13.26 per cent per annum between 2007 and 2015, compared with 29.22 per cent per annum under monetary aggregates targeting. The relatively lower inflation rates notwithstanding, an average inflation rate of 13.2 per cent per annum is far above the medium‐term target of 8 per cent. This paper has examined the effectiveness of monetary aggregates targeting and inflation targeting in keeping inflation at moderate levels. The autoregressive distributed lag (ARDL) model was applied to the data covering the period 1970–2015. The results show that monetary targeting has steered inflation to moderate levels only in the short run while inflation targeting has maintained low inflation rates in both short run and long run. But neither regime has kept inflation at stable levels and within the target band, due to the sluggish transmission of broad money supply and prime rate changes to inflation. We implore the monetary authorities to strengthen the institutional setup for steering short‐term interest rates in Ghana. They should also enhance the BoG Act 2002 (Act 612), to develop secondary anchors and rules around output, money supply and fiscal deficit. Finally, the monetary policy committee should monetary policy credibility and transparency through strengthening its communication framework.     

Optimal Exchange Intervention in an Inflation Targeting Regime: Some Cautionary Tales

Devaluations and fiscal retrenchments coming from developed countries are buffeting less developed countries. Many emerging market countries have adopted inflation targeting as “best practice,” but now they are being advised to enhance their inflation targeting regimes with foreign exchange intervention. Here we use a DSGE model to tell some cautionary tales about this advice. A Taylor rule guides interest rate setting, while foreign exchange interventions are used as a second tool of monetary policy. These interventions are effective in our model since domestic and key currency bonds are imperfect substitutes. We derive optimal (Ramsey) intervention policies in response to foreign devaluations and fiscal retrenchments, and find that they are rather complex. So, we compare the optimal responses to policies that simply smooth real or nominal exchange rate movements. Our results suggest that discretion may be the better part of valor: pure inflation targeting may come closer to the optimal policy than exchange rate smoothing. A secondary result may also be of some interest: foreign exchange interventions have a stronger impact on inflation and output in an inflation targeting regime than do sterilized interventions; the Taylor rule augments the effects of a given intervention.     

Optimal Monetary Policy Rules and Inflation Targets: Are Australia,Canada, and New Zealand Different from the U.S.?

Outwardly, the central banks of Australia, Canada, New Zealand, and the U.S. follow somewhat different approaches to controlling inflation. The U.S. does not explicitly target inflation while the other countries do. Canada and New Zealand have target bands for inflation while Australia has a point target. Results in this paper nevertheless find broad similarities in the monetary policies of these countries. Each can be described as having pursued optimal inflation targeting (explicit or implicit), with heavy interest rate smoothing, but perhaps placing little weight on output variability. We argue that interest rate smoothing is used to introduce gradualism into the response of monetary policy to inflation. We show that given heavy interest rate smoothing, a concern for output variability is redundant.     

Fiscal-monetary Interactions: The Effect of Fiscal Restraint and Public Monitoring on Central Bank Credibility

This paper offers new insights into the interactions between private agents, the government, and a central bank, and their effect on the outcomes of monetary policy. In a simple game theoretic model we show that, unless there is public monitoring, impatient governments will be tempted to override or outmaneuver the central bank and create surprise inflation to boost output. This both undermines the government’s reputation for sound fiscal policies and reduces the central bank’s credibility. The result is not only higher and more volatile inflation but also sub-optimal output. More importantly, it is also shown that this is likely to occur even if the central banker is fully independent and the government is always patient. In contrast, if the public monitors sufficiently carefully, the central bank is never overridden and monetary policy can be credible even under an impatient government. We derive the general conditions under which each scenario occurs and then relate them to the developments in central banking over the past two decades, most notably to the trends towards greater independence, explicit inflation targeting, clearer communication and transparency. Interestingly, transparency is shown to reduce the variability of both inflation and output (by reducing the monitoring cost and making public monitoring more likely) which is in contrast to the usual transparency literature with a single policymaker which supposes a transparency-volatility trade-off.

Reactions to Shocks and Monetary Policy Regimes: Inflation Targeting Versus Flexible Currency Board in Sub‐Saharan Africa

The paper examines the monetary policy actions through which central banks in sub‐Saharan Africa have tried to eliminate the negative impacts of the shocks facing their economies. We compare two different monetary policy regimes: a currency board regime (in the CFA zone) and an inflation targeting policy regime (Ghana and South Africa) when central banks respond to demand, supply, and fiscal shocks. We extend the usual forecasting and policy analysis system models to replicate the economic features of these economies during the period 2002–12 and to evaluate the impact of several policies in response to these shocks. We find that both policies are inappropriate in helping the economies escape from the effects of negative demand shocks, both are essential when negative shocks to primary balance occur, while inflation targeting dominates the currency board regime as a strategy to cope with positive shocks to inflation.     

Rotating Slumps in a Monetary Union

In the decade since its creation in 1999, the European Economic and Monetary Union (EMU) has experienced surprisingly large and persistent inflation differentials across member states causing substantial shifts in relative price levels. At the same time, member countries exhibited distinct non-synchronized output fluctuations, giving rise to a pattern of ‘rotating slumps’ (a term coined by Olivier Blanchard). This paper presents a stylized theoretical model of a monetary union which demonstrates how inflation differentials and relative output movements interact dynamically. A number of implications are derived from the model. In particular, national fiscal policies are shown to have an important role in containing internal macroeconomic disparities in a monetary union. An optimal fiscal policy rule is derived from the model for that purpose.     

Optimal Monetary Policy in China

Using the structural vector autoregression model, we estimate the current responses of monetary policy to contemporaneous shocks from macroeconomic variables. Our findings indicate that the People's Bank of China responded to inflation and output changes, but did not react to asset price fluctuations during the period from January 1997 to March 2010. The optimal monetary responses to exogenous shocks are also examined. It is revealed that using asset prices to formulate monetary policy would not help to improve monetary authorities' performance in lowering the volatilities of output growth and inflation while keeping output growth and inflation in their safety zones. The effectiveness of monetary policy and fiscal policy in reacting to external shocks is also discussed.     

Policy Shocks and Macroeconomic Fluctuations in a Two‐country Dynamic Stochastic General Equilibrium Model: Evidence from China*

In this paper, we construct a two‐country dynamic stochastic general equilibrium model to investigate the sources of business cycles in China and the contributions of policy shocks in economic fluctuations. The empirical results from Bayesian estimation show that, apart from the traditional supply and demand shocks, monetary and fiscal policy shocks also play important roles in determining China's economic fluctuations. In addition, we find significant feedback effects between monetary and fiscal policies in China, indicating that policy coordination is an important feature of China's monetary and fiscal policies. Overall, these results not only shed new light on the policy factors behind China's economic fluctuations, but also provide new evidence that is helpful for understanding the policy transmission mechanisms in China.     

Inflation,economic activity and the operation of fiscal,foreign and monetary impulses in the Netherlands — A preliminary analysis, 1953–1973

Summary This paper tests both the strong and weak versions of the fiscal, foreign and monetary impulse hypotheses holding that each of these impulses is either a sufficient or a necessary condition for fluctuations in price and output to occur.Four impulses are distinguished: a fiscal impulse being a linear combination of autonomous changes in government expenditures and taxes, two foreign impulses measured by the growth rates of world trade and import prices, and a monetary impulse measured by (changes in) the growth rate of the stock of domestic or world money.When tested against the Dutch post-war experience of inflation and output fluctuations, all strong impulse hypotheses have to be rejected, as do the weak fiscal and foreign world trade hypotheses with respect to inflation and the weak fiscal hypotheses with respect to output growth. The weak foreign and monetary impulse hypotheses of output fluctuations, however, and the weak foreign import price and monetarist hypotheses of inflation are not rejected.     

Transatlantic Trade-Offs in the Age of Balanced Budgets and European Monetary Union

We develop a model of monetary and fiscal policies appropriate for considering U.S.-European policy interactions in an era of near-balanced budgets and European monetary union. We study the determinants of policy trade-offs and incentives for central banks and governments across the Atlantic. Smaller, more open economies face more favorable trade-offs, since openness enhances policy effectiveness via the exchange-rate channel. Changes in Europe's monetary arrangements do not affect U.S. trade-offs, although they alter the trade-offs facing European policy-makers. Fiscal trade-offs depend crucially on the extent to which fiscal policy is distortionary. Changes in taxes and spending move both employment and inflation in the desired direction following a worldwide supply shock when spending is financed with distortionary taxes.     

Stable and enforceable: a new fiscal framework for the Euro area

Since the great financial crash, the need for new fiscal rules to prevent unsustainable fiscal policies is universally recognised. In practice such rules, including those in the Stability and Growth Pact, have proved to be impossible to enforce. Thus, to avoid unsustainable fiscal policies reappearing, and to prevent monetary policy from being undermined by undisciplined governments, there is a need for a framework capable of imposing fiscal discipline. This paper considers an intertemporal assignment, where fiscal policy focuses on long-term objectives and monetary policy on short-term stabilisation. We argue for public sector debt targets as a practical way to achieve such a set up, and an excess debt protocol is constructed to give enforceable form to those targets. The ideas of “fiscal space” and optimal debt levels are used to provide a mechanism for identifying a stable region within which the debt targeting regime should operate. Making these factors explicit would both improve the credibility of planned fiscal policies and reduce risk premia on borrowing costs. We finally show how Europe’s competitiveness pact, and debt restructuring operations, can be used to maximise the available fiscal space.     

Inflation Targeting as a Coordination Device

The paper analyses inflation targeting when two independent policy authorities (a central bank and a National Government) have divergent preferences for the optimal policy mix. We demonstrate that the main advantage of inflation targeting, as a policy regime, is that it represents a simple proxy for full coordination between policy authorities. Inflation targeting therefore helps because it reduces the conflicts between fiscal and monetary policy, expecially where there are strong spillovers between the two policies. These results are then tested, and largely validated, in a simulation framework using a small open economy calibrated model.