The monetary policy
Trimis la data: 2011-02-16
Nota: 9.25 / 10
Autor: Ionela Tonca
Tipul fisierelor: doc
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The monetary base can not reasonably be controlled in the short run. By definition (see chapter 1) an operational target variable should be a variable that can be controlled in the very short run by the central bank and for which a concrete figure is set by the decision-making committee for the inter-meeting period to (a) tell the central bank's implementation experts what to do, and (b) indicate the stance of monetary policy to the public. However, this obviously does not make sense for the monetary base. Its normally biggest component, banknotes in circulation, is in the short term purely demand-driven with innovations to demand.
In particular, the multiplier is unlikely to remain stable when interest rates move towards zero, since banks then no longer care about holding excess reserves. To that extent, when monetary growth is deemed insufficient and excess reserves are injected to make the banks expand credit, the result will be first that, in an efficient market, short-term inter-bank interest rates drop to zero (if there is no deposit facility).
The fact that interest rates have dropped to zero is, of course, relevant and, if judged to be permanent for a longer period of time, medium-and longer-term rates also will drop and economic decisions will be affected. However, once inter-banks rates have fallen to zero and the central bank continues to increase excess reserves through open market operations at zero interest rates, not much more should happen: that is, the money multiplier should fall with every further reserves injection.
It is to that extent difficult to really construct a story where an injection of reserves by the central bank through open market operations sets in motion monetary expansion independently from the interest rate channel. Third, any attempt to control in the short run the monetary base leads to extreme volatility of interest rates since the market will, due to stochastic and seasonal fluctuations in the demand for base money, permanently either be short or long of reserves, as already observed by Bagehot (1873).
One of the core ideas of central banking is to provide an "elastic currency", that is, one in which the important transitory fluctuations in base money demand no longer need to disturb economic conditions via interest rate effects. What matters for the key economic decisions, namely, to save or consume, to borrow or invest, is interest rates mainly of medium and longer maturity.
With extreme volatility of short-term rates, the volatility of longer-term rates will also increase. Such volatility will create noise in economic decisions, and hence lead the economy away from equilibrium.
3. Alternative quantitative concepts as operational targets.
The Fed and academics, confronted with the conceptual problems of monetary base targeting while still aiming at a framework in which monetary policy transmission could be defined only in terms of quantities from the very start, soon developed alternative quantitative targets.
Alternative quantitative concepts applied temporarily as operational target in the US were free, non-borrowed, and borrowed reserves, and M. Friedman (1982) even seems to be proposing an open market operations volume target. In addition, total reserves targeting was also discussed in the literature (see Meigs 1962).
By focusing on reserves, these approaches eliminated the defect of monetary base targeting, which was to put three fundamentally different things, namely, banknotes, required reserves, and excess reserves, into one basket. Also, controlling these quantities in the very short run was clearly easier than controlling the monetary base. However, these approaches were correspondingly less directly linked to the money multiplier story, and therefore needed additional, more complex theoretical justification.
Although some justifications were given, today they are judged to be inadequate. The non-borrowed reserves target applied from 1979 to 1982 was not only complex to derive but also created volatility in both longer-term interest rates and monetary aggregates.
The free and borrowed reserves targets, in contrast, seem to be rather close to an interest rate target: their theoretical justification, apart from that of being substitutes for short-term rates, appear so weak, and their use was in practice so lacking in transparency, that it seems that they were always smokescreens for short-term interest rate targeting (see for example Goodfriend 2003 and Mishkin 2004).
It was argued in Chapter 7 that the derived quantitative operational targets contain instabilities that require a frequent redefinition of targets independently of macroeconomic events, which weakens the concepts considerably. This is underlined by the fact that Fed never published concrete figures for its supposed quantitative targets.
This contrasts with short-term interest rates as operational targets, witch can be specified unambiguously and published for the periods between the meetings of the decision-making committee.
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