Monetary policy and financial stability: what role for the interest rate?

We propose an ex-post analysis of the behavior of a central bank confronted with financial turmoil. For this purpose, we rely on a DSGE model that combines credit market frictions with a boom and bust scenario on the price of capital. Within this framework, we seek to understand the extent to which central banks could have intervened to limit the effects of the financial bubble and its bursting. We compare the results obtained in terms of economic stabilization under a simple Taylor rule with those of an augmented rule that takes into account a financial indicator. We show that a central bank using as sole instrument the interest rate cannot simultaneously improve inflation and credit cycles.     

The Role of Monetary Policy in Japan: A Break in the 1990s?

This article documents time series evidence suggesting the case for a possible structural break in the role of Japan's monetary policy during the 1990s. It uses a simple vector autoregressive framework and offers some suggestive results: While a persistent effect of monetary policy on real output is detected over the full sample of 1975–1998 and the subsample that ends in 1993, such effect disappears with the recent subsample of the 1990s. The stability analysis also provides more specified evidence that there is a break in the reduced form dynamic system in 1995. Some interpretations are offered to intuitively support these findings. J. Japan. Int. Econ., December 2000, 14(4), pp. 366–384. Research Institute for Economics and Business Administration, Kobe University, Rokko, Nada, Kobe 657-8501, Japan Copyright 2000 Academic Press.Journal of Economic Literature Classification Numbers: E52, E32.     

Do Mandatory Pensions decrease Household Savings? Evidence for the Netherlands

The Dutch mandatory pension system consists of two parts: a public pay-as-you-go part that provides a minimum income to all Dutch inhabitants over age 64 and an occupation-specific capital-funded part that provides supplementary retirement income. The goal of this paper is to test for the effect of mandatory pensions on discretionary household savings. The data are drawn from the CentER Savings Survey. A result of the empirical analysis is that the impact of the public part of the Dutch pension system is not well identified. The occupational pensions have a significant negative impact on savings motives with respect to old age. The evidence on the effect on household wealth is mixed.     

Introduction: A New Architecture or New System? A Survey of International Monetary Reform in the 1990s

The international monetary system (IMS) is a macroeconomic concept that encompasses the foreign exchange-rate regulation, the capital movement system, and all “the rules of the game” for the adjustment of international payment imbalances. The international financial architecture (IFA) is, in contrast, a microeconomic concept and should not be considered synonymous with the IMS. The IFA is one element of the IMS. The current set of international monetary arrangements has been frequently called a “nonsystem.” Today there are two missing pillars in the reform efforts: a framework for managing the interdependence among the macroeconomic policies of the global powers (the United States, Europe, and Japan) and the market-oriented approach to the financing of the IMF.     

Modern Monetary Theory: A Solid Theoretical Foundation of Economic Policy?

Atlantic Economic Journal - This paper shows that so-called modern monetary theory (MMT) lacks a sound economic foundation for its far-reaching policy recommendations. This paper’s main...     

Does Central Bank Capital Matter for Monetary Policy?

This paper examines empirically whether central bank capital influences the conduct of monetary policy. To this end, we estimate interest rate rules for a sample of 41 countries and employ linear and non-linear regression methods to test if a measure of central bank financial strength can explain deviations of actual interest rates from those predicted by the estimated interest rate (Taylor-like) rules. Our results suggest that central bank capital is indeed a relevant factor behind interest rate policy decisions.     

Monetary policy and the behaviour of inflation in India: Is there a need for institutional reform?

Inflation rates in a number of developed countries follow a common trend over the past five decades: inflation starts out low in the 1950s, rises for a time before peaking in the 1970s, and then falls back to initial levels. Interestingly the behaviour of trend inflation in India broadly exhibits such a pattern. This similarity in the behaviour suggests that any explanation of inflation ought to apply across countries. To this end we construct a reduced-form inflation model for India that encompasses various well-known policy mistake theories as special cases. The restriction imposed by each of these theories on the behaviour of inflation is tested empirically. Reduced-form estimates lend support to all these theories. Although the reason for the inflation bias differs from one theory to the other, the mechanism at the heart of these theories are in fact quite similar. They all lay responsibility for inflation with the nature of monetary institutions. We use these results to interpret India's inflation experience over the past five decades and discuss the implications for institutional reform.     

Indonesian Monetary Policy During the 1997–98 Crisis: A Monetarist Perspective

This paper defends the IMF's strategy of targeting base money (M0) in 1997–98 against the criticism by Grenville (2000) that it was destined to fail because M0 is mainly demand determined and the demand for it was increased by a large and unpredictable amount by the banking panic. Grenville contends that Indonesian monetary policy should have aimed at domestic price stability. It is argued here that the growth of M0 far exceeded what could be justified by last resort lending to accommodate the banking panic, and that rapid inflation could only have been avoided by preventing most of the expansion of the public's cash holding that actually occurred. Achieving a modest target for domestic inflation would not therefore have been very different in practice from setting tight limits on the growth of M0. In contrast, both these policies would have been very different from the loss of control over M0 that actually occurred.     

Will Ageing Lead to a Higher Real Exchange Rate for the Netherlands?

Long term projections for the Netherlands indicate that demand for nontradables—e.g. health care services—will increase relative to supply due to population ageing. If this leads to higher future real exchanges rates this will erode the return of the savings currently made to prepare for ageing. This paper explores the magnitude of potential price effects using a modified version of the two country, four commodity framework developed by Obstfeld and Rogoff (Brookings Papers Econ Activity 1:67–146, 2005) to explore the exchange rate effects of the balance of payments reversal in the US. When these price effects are substantial this may have serious consequences for policies to enhance national saving in the Netherlands.     

Openness to Trade and the Potency of Monetary Policy: How Strong is the Relationship?

Economic theory suggests that an economy's openness to international trade reduces the ability of monetary policy to affect output. Using quarterly data from the 1960:1–1993:4 period for a set of eight countries (Australia, Canada, Germany, Italy, Japan, South Africa, the U.K., and the U.S.A.), this article's empirical results support this theoretical prediction: the more open the economy, the smaller the output effects of a given change in the money supply. This finding, robust across all the different specifications and estimation methods examined, has straightforward implications for stabilization policy. Moreover, it suggests that an economy's net benefit from joining a monetary union is increasing with the economy's openness to foreign trade.     

Which Method Should the Central Bank Choose to Estimate the Model Economy? A Korean Monetary Policy Example

Abstract

To understand how the macro economy evolves, the central bank has two options in choosing how to estimate the economic model against actual data: one is to estimate each sector of the model piece-by-piece, and the other is to estimate the whole model altogether. This paper demonstrates the advantage for the central bank of estimating the whole model in terms of the estimation accuracy and the robustness of the resulting policy recommendations. For that aim, we construct a macro model for the monetary policy analysis of the Korean economy and estimate the model via the system approach and single-equation approach. We evaluate the data fits of the two estimation results and show that the fit of the system approach is far better than the other and comparable to other methods such as vector autoregressions. It is also shown that, if the two estimated models are equally likely, conducting the policy tailored for the model estimated by the system approach delivers better stabilization results for the Korean economy.     

Why does the Monetary Policy Committee smooth interest rates?

Explanations of why the monetary authorities in different countriesseem to smooth interest rates have focused on the official dislikeof financial market volatility, aspects of the decision-makingprocess, responses to uncertainty, inertial behaviour in a forward-lookingenvironment, and serial correlation of shocks to the policymakers'expectations. This paper first shows that policy has been smoothestand comparable to that in other countries in the period of inflationtargeting with Bank of England control of interest rates since1997. It then uses the remarkably detailed evidence availablefrom the minutes of the Monetary Policy Committee to evaluatethe relevance of the various explanations of smoothing for theUK in this period. The paper concludes that the explanationof interest rate smoothing should be sought primarily in theserial correlation of shocks, together with some minor and short-terminfluences from uncertainty, while the other explanations turnout to be not relevant.     

Fiscal Sustainability in the Euro-Zone: Is There A Role for Euro-Bonds?

This paper assesses the fiscal sustainability of ten Eurozone member countries at a national and aggregate level. It is carried out in light of the relevant literature on monetary unions and the framework of the European Monetary Union vis-à-vis the current sovereign debt crisis. The impact of Eurobonds, which are considered as a viable solution, on fiscal sustainability was empirically tested. The results indicate that only three countries appear to be structurally sustainable whereas the majority of the countries are only sustainable in the short-run and two countries are structurally unsustainable. However, the sustainability of the Eurozone is greatly improved when the Eurobonds are used.     

The industrial revolution and the Netherlands: Why did it not happen?

Why was the Netherlands not a leader in the first Industrial Revolution (1760-1830) despite its advanced economy in the eighteenth century? This paper argues that the Industrial Revolution in its early stages required a close cooperation between knowledge of nature and its application to technology. The closeness of natural philosophers, engineers, and entrepreneurs was a key to success in Britain. In the Netherlands, a combination of cultural relics from the Golden Age and unfortunate political events after 1780 combined to delay the technological development. As a small, open economy, the country eventually overcame its obstacles and joined modern western industrial progress after 1860.     

Is Numérairology the Future of Monetary Economics?

The paper discusses some fundamental problems in monetary economics associated with the determination and role of the numéraire. The issues are introduced by formalising a proposal, attributed to Eisler, to remove the zero lower bound on nominal interest rates by unbundling the numéraire and medium of exchange/means of payment functions of money. The monetary authorities manage the exchange rate between the numéraire (‘sterling’) and the means of payment (‘drachma’). The short nominal interest rate on sterling bonds can then be used to target stability for the sterling price level. The paper puts question marks behind two key bits of conventional wisdom in contemporary monetary economics. The first is the assumption that the monetary authorities define and determine the numéraire used in private transactions. The second is the proposition that price stability in terms of that numéraire is the appropriate objective of monetary policy. The paper also discusses the merits of the next step following the decoupling of the numéraire from the currency: doing away with currency altogether—the cashless economy. Because the unit of account plays such a central role in New-Keynesian models with nominal rigidities, monetary economics needs to devote more attention to numérairology—the study of the individual and collective choice processes that govern the adoption of a unit of account and its role in economic behaviour.

Optimal Currency Area: A twentieth Century Idea for the twenty-first Century?

We take stock of the history of the European Monetary Union and pegged exchange-rate regimes in recent decades. The post-Bretton Woods greater financial integration and under-regulated financial intermediation have increased the cost of sustaining a currency area and other forms of fixed exchange-rate regimes. Financial crises illustrated that fast-moving asymmetric financial shocks interacting with real distortions pose a grave threat to the stability of currency areas and fixed exchange-rate regimes. Members of a currency union with closer financial links may accumulate asymmetric balance-sheet exposure over time, becoming more susceptible to sudden-stop crises. In a phase of deepening financial ties, countries may end up with more correlated business cycles. Down the road, debtor countries that rely on financial inflows to fund structural imbalances may be exposed to devastating sudden-stop crises, subsequently reducing the correlation of business cycles between currency area’s members, possibly ceasing the gains from membership in a currency union. A currency union of developing countries anchored to a leading global currency stabilizes inflation at a cost of inhibiting the use of monetary policy to deal with real and financial shocks. Currency unions with low financial depth and low financial integration of its members may be more stable at a cost of inhibiting the growth of sectors depending on bank funding.