PRICE STABILITY AND THE ECB'S MONETARY POLICY STRATEGY*

Abstract.  This paper focuses on the price stability objective within the framework of the single monetary policy strategy. It starts by reviewing what this objective, which is common to all central banks, means. Second, this paper focuses exclusively on the anchoring of short- to medium-term inflation expectations (Part 2). Several measures show that this anchoring is effective. A 'two-pillar' small structural macro-economic model framework is used to analyze the impact that this anchoring of expectations has on the determination of the short- to medium-term inflation rate. From this point of view, observed inflation in the euro area seems to be in line with the theory and the ECB's action seems to be very effective. Third, we focus on the other aspect of monetary stability: the degree of price-level uncertainty and the anchoring of inflation expectations in the medium to long term. Even though this assessment is more difficult than it is in the short to medium term, since we only have a track record covering 6 years, various indicators from the theoretical analysis paint a fairly reassuring picture of the effectiveness of the device used by the ECB.     

THE DECISIONS OF THE SHADOW MONETARY POLICY COMMITTEE AND MONETARY POLICY COMMITTEE SINCE 2002

We analyse the decisions of the Monetary Policy Committee (MPC) and the recommendations of the Shadow Monetary Policy Committee (SMPC) over the period 2002–2011. We find that the SMPC policy recommendations have to a large extent agreed with the policy actions of the MPC on interest rates. We offer some suggestions as to how the recommendations of the SMPC could be enhanced.     

CLASSIFYING MONETARY ECONOMICS: FIELDS AND METHODS FROM PAST TO FUTURE

Abstract We propose a simple, yet sufficiently encompassing, classification scheme of monetary economics. It comprises three fundamental fields and six recent areas that expand within and across these fields. The elements of our scheme are not found together and in their mutual relationships in earlier studies of the relevant literature; neither does this attempt aim to produce a relatively complete systematization. Our intention in taking stock is not finality or exhaustiveness. We rather suggest a viewpoint and a possible ordering of the accumulating knowledge. Our purpose is to promote discussion on the evolving nature and internal consistency of monetary economics at large.     

MACRO‐FINANCE LINKAGES

In this survey, I review the academic and policy‐oriented literature on the linkages between financial markets and the rest of the economy. First, I summarize the leading economic theories for why the financial sector can influence the macroeconomy. Second, I consider empirical research on spillovers from the financial sector to the rest of the economy, as well as across financial markets in different countries. Third, I discuss key monetary policy debates regarding the appropriate response of central banks to financial conditions. Finally, I conclude with an overview of the major gaps in the existing literature.     

MONETARY POLICY IN A NON‐REPRESENTATIVE AGENT ECONOMY: A SURVEY

It is well known that central bank policies affect not only macroeconomic aggregates, but also their distribution across economic agents. Similarly, a number of papers demonstrated that heterogeneity of agents may matter for the transmission of monetary policy to macro variables. Despite this, the mainstream monetary economics literature has so far been dominated by dynamic stochastic general equilibrium models with representative agents. This paper aims to tilt this imbalance towards heterogeneous agents setups by surveying the main positive and normative findings of this line of the literature, and suggesting areas in which these models could be implemented. In particular, we review studies that analyse the heterogeneity of (i) households’ income, (ii) households’ preferences, (iii) consumers’ age, (iv) expectations and (v) firms’ productivity and financial position. We highlight the results on issues that, by construction, cannot be investigated in a representative agent framework and discuss important papers modifying the findings from the representative agent literature.     

THE REGIONAL EFFECTS OF MONETARY POLICY: A SURVEY OF THE EMPIRICAL LITERATURE

This survey provides an updated review of the empirical literature on the regional effects of monetary policy in economic activity by means of undertaking a threefold perspective. First, the main methodological dimensions of this literature are examined while pinpointing those modelling or methodological traits that constitute a source of diverging estimates and thereby produce inconclusive evidence. Secondly, the estimates yielded by the literature are summarized by carrying out a cross‐study analysis of the results for each monetary union. By drawing on empirical regularities that are robust across studies, the conclusiveness of the results is assessed, while those monetary unions for which conclusive evidence is still lacking are also identified. Lastly, the sources of regional heterogeneity identified by these studies are reviewed in order to shed some light on the linkage between monetary policy and territorial heterogeneity. As a result of this threefold perspective, this survey delivers overall structured conclusions and updated policy‐relevant lessons. Moreover, various research gaps and emerging topics in the literature are also identified.     

MONETARY POLICY AND ECONOMIC IMBALANCES: AN ETHNOGRAPHIC EXAMINATION OF CENTRAL BANK RITUALS

We apply the ethnographic tools of economic anthropology to analyse a particular ritual performed by the high priest of the Arbee sub‐tribe in the South Pacific island group of Aotearoa. (In other island groups, this high priest is sometimes known as the Governor of the Reserve Bank of New Zealand.) The ritual is considered by many within Aotearoa to be the cause of The Imbalance in The Economy. We analyse this claim and show that it has similarities (and equal validity) to claims of other cargo cults within the South‐West Pacific region.     

Monetary policy and the term premium

The term premium has become increasingly important in discussions of monetary policy formulation. This paper reviews two approaches to embedding a variable term premium into an otherwise standard modern DSGE model. The first approach maintains frictionless asset trade but alters preferences so that agents are more averse to the risk in long bonds. The second approach uses traditional preferences, but segments asset trade between long and short bonds. Policy issues are also discussed.     

MONETARY AND FISCAL POLICIES INTERACTION IN MONETARY UNIONS

In this paper, the literature on the interaction between monetary and fiscal policies in a monetary union is surveyed. By adopting the concept of symbiosis as a starting point, the paper highlights the importance of uncertainty, policy makers' preferences and targets. Then, the role of commitment to policy rules and coordination is addressed. The analysis also focuses on the importance of the data considered for the generation of the policy mix. As a final step, the paper discusses the main results in the literature on public debt management in a monetary union. All the reported theoretical results are then adopted to retrieve policy and institutional implications for the European Monetary Union.     

EXPERIMENTAL ASSET MARKETS WITHIN FINANCE

Abstract. This paper addresses the concept of market efficiency, presenting a critical review of the conventional tests in the area, which in turn provides the justification for employing an experimental methodology. The literature on experimental asset markets within finance is then reviewed and evaluated.     

DELIBERATIVE MONETARY VALUATION: IN SEARCH OF A DEMOCRATIC AND VALUE PLURAL APPROACH TO ENVIRONMENTAL POLICY

The use of deliberative methods to assess environmental values in monetary terms has been motivated by the potential for small group discussion to help with preference formation and the inclusion of non‐economic values. In this review, two broad approaches are identified: preference economisation and preference moralisation. The former is analytical, concentrates upon issues of poor respondent cognition and produces a narrow conception of value linked to utilitarianism. The latter emphasises political legitimacy, appeals to community values and tends to privilege arguments made in the public interest. Both approaches are shown to embrace forms of value convergence, which undermine the prospects for value pluralism. As a result exclusion and predefinition of values dominates current practice. In order to maintain democratic credentials, the importance attributed to monetary value needs to be left as an open question to be addressed as part of a process determining an “agreement to pay”. To this end we identify a discourse‐based approach as a third way consistent with the democratic and value plural potential of deliberative monetary valuation.     

NON-WELFARIST OPTIMAL TAXATION AND BEHAVIOURAL PUBLIC ECONOMICS

Abstract.  Research in behavioural economics has uncovered the widespread phenomenon of people making decisions against their own good intentions. In these situations, the government might want to intervene, indeed individuals might want the government to intervene, to induce behaviour that is closer to what individuals wish they were doing. The analysis of such corrective interventions, through taxes and subsidies, might be called 'behavioural public economics'. However, such analysis, where the government has an objective function that is different from that of individuals, is not new in public economics. In these cases the government is said to be 'non-welfarist' in its objectives, and there is a long tradition of non-welfarist welfare economics, especially the analysis of optimal taxation and subsidy policy where the outcomes of individual behaviour are evaluated using a preference function different from the one that generated the outcomes. First of all the object of this paper is to present a unified view of the non-welfarist optimal taxation literature and, second, to present behavioural public economics as a natural special case of this general framework.     

PRICE-LEVEL TARGETING AND STABILISATION POLICY: A SURVEY

Abstract.  This paper surveys recent articles on the costs and benefits of price-level targeting, focusing its use as a tool for stabilisation policy. It discusses how price-level targeting can affect the short-run trade-off between output and inflation variability by influencing inflation expectations. It reviews how assigning an explicit price-level target to a central bank that is unable to commit to its future policies can improve economic performance. It surveys other potential benefits and costs. Among the costs, it underlines the importance of perfectly rational expectations for the optimality of price-level targeting, and an exacerbation of the time inconsistency problem.     

MONETARY POLICY AND THE CREDIT CRUNCH

This article examines how interest rates should have been changed in response to the commodity price shock and the credit crunch under different assumptions for the decision rules that might be used by central banks.     

Asset market response to monetary policy news from SNB press releases

This paper analyses the effects of Swiss National Bank (SNB) communication on asset prices. It distinguishes between different monetary policy news contained in press releases following a monetary policy decision. Employing a latent variable approach and event-study methods, I find that medium- and long-term bond yields respond to changes in the communicated inflation and GDP forecasts as well as to the degree of pessimism expressed in press releases. Exchange rates mainly react to changes in the GDP forecast while stocks do not react to SNB communication on monetary policy announcement days. Additionally, short-term expectations about the future path of the policy rate are driven by the communicated inflation forecast. The results underline the role of qualitative news beyond quantitative forecasts in influencing market expectations and asset prices.     

THE DECISIONS OF THE SHADOW MONETARY POLICY COMMITTEE AND MONETARY POLICY COMMITTEE SINCE 2002: A REJOINDER

Koo, Paya and Peel make some very worthwhile points regarding the operation of the SMPC. Their analysis is interesting and helpful. However, the particular structure of the SMPC and the way it operates is, to some extent, determined by practicalities but also, more importantly, by the fact that it tries to operate as a discussion forum bringing together academics, bankers and financial experts rather than simply providing opinions on what the MPC should do.     

WHAT CAN WE LEARN FROM THE IMPLEMENTATION OF MONETARY AND MACROPRUDENTIAL POLICIES: A SYSTEMATIC LITERATURE REVIEW

The emergence of macroprudential policies, implemented by central banks as a means of promoting financial stability, has raised many questions regarding the interaction between monetary and macroprudential policies. Given the limited number of studies available, this paper sheds light on this issue by providing a critical and systematic review of the literature. To this end, we divide the theoretical and empirical studies into two broad channels of borrowers – consisting of the cost of funds and the collateral constraint – and financial intermediaries – consisting of risk‐taking and payment systems. In spite of the existing ambiguity surrounding coordination issues between monetary and macroprudential policies, it is argued that monetary policy alone is not sufficient to maintain macroeconomic and financial stability. Hence, macroprudential policies are needed to supplement monetary. In addition, we find that the role of the exchange rate is critical in the implementation of monetary and macroprudential policies in emerging markets, while volatile capital flows pose another challenge. In so far as how the arrangement of monetary and macroprudential policies varies across countries, key theoretical and policy implications have been identified.     

CO‐INTEGRATING VAR MODELS AND ECONOMIC POLICY

This paper surveys some relevant contributions to the economic literature on co‐integrating vector autoregressive (VAR) models [vector error correction mechanisms (VECMs)], emphasizing their usefulness for economic policy. It further discusses some theoretical aspects that are necessary for a complete understanding of their potential. The theoretical introduction of the co‐integrating VAR model is followed by an illustration of its applications to monetary policy, fiscal policy and exchanges rates as well as in establishing the effects of structural bilateral shocks between countries (the so‐called global VAR, or GVAR, models). Special attention is paid to the VECM capacities of being used in conjunction with dynamic stochastic general equilibrium models and of jointly specifying the short‐ and long‐run dynamics, thus representing the steady‐state of economic systems (by means of the co‐integration relations) and the short‐run dynamics around it.