2008 pearson education canada18.1 chapter 18 what should central banks do? monetary policy goals,...
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© 2008 Pearson Education Canada18.3 Other Goals of Monetary Policy High employment Economic growth Stability of financial markets Interest-rate stability Foreign exchange market stabilityTRANSCRIPT
© 2008 Pearson Education Canada18.1
Chapter 18Chapter 18What Should Central Banks Do? Monetary Policy Goals, Strategy and Tactics
© 2008 Pearson Education Canada18.2
The Price Stability GoalThe Price Stability Goal• Low and stable inflation• Inflation
– Creates uncertainty and difficulty in planning for future
– Lowers economic growth– Strains social fabric
• Nominal anchor ignore
• Time-inconsistency problem ignore
© 2008 Pearson Education Canada18.3
Other Goals of Monetary PolicyOther Goals of Monetary Policy
• High employment• Economic growth• Stability of financial markets• Interest-rate stability• Foreign exchange market stability
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Should Price Stability be the Should Price Stability be the Primary Goal?Primary Goal?
• In the long run there is no conflict between the goals
• In the short run it can conflict with the goals of high employment and interest-rate stability
• Hierarchical mandate• Dual mandate
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Monetary TargetingMonetary Targeting• Flexible, transparent, accountable• Advantages
– Almost immediate signals help fix inflation expectations and produce less inflation
– Almost immediate accountability
• Disadvantages– Must be a strong and reliable relationship between the
goal variable and the targeted monetary aggregate
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Inflation Targeting Inflation Targeting • Public announcement of medium-term numerical
target for inflation• Institutional commitment to price stability as the
primary, long-run goal of monetary policy and a commitment to achieve the inflation goal
• Information-inclusive approach in which many variables are used in making decisions
• Increased transparency of the strategy• Increased accountability of the central bank
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Inflation Targeting In Inflation Targeting In Canada Canada
• In 1991, the minister of finance and the governor of the Bank of Canada established formal inflation targets
• The target range was 2-4% by the end of 1992, 1.5-3% by June 1994 and 1-3% by December 1996
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• After a new government took office in 1993, the target was set at 1-3% and has been kept at this level ever since
• Canadian inflation has fallen dramatically since the adoption of targets, falling from 5% in 1991, to zero in 1995 and between 1-2% in the late 1990’s
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Inflation TargetingInflation Targeting
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Inflation Targeting Inflation Targeting (Cont’d)(Cont’d)
• Advantages– Does not rely on one variable to achieve
target– Easily understood– Reduces potential of falling in
time-inconsistency trap– Stresses transparency and accountability
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• Disadvantages– Delayed signaling– Too much rigidity– Potential for increased output fluctuations– Low economic growth
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Implicit Nominal AnchorImplicit Nominal Anchor• Brief discussion
• Forward looking and preemptive• Advantages
– Uses many sources of information– Avoids time-inconsistency problem– Demonstrated success
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• Disadvantages– Lack of transparency and accountability– Strong dependence on the preferences, skills,
and trustworthiness of individuals in charge– Inconsistent with democratic principles
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Advantage and Disadvantages of Advantage and Disadvantages of Different Monetary StrategiesDifferent Monetary Strategies
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Tactics: Tactics: Choosing the Policy InstrumentChoosing the Policy Instrument
• Tools– Open market operation– Government deposit shifting– Last resort lending– Overnight interest rate
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• Policy instrument (operating instrument)– Reserve aggregates– Interest rates– May be linked to an intermediate target
• Interest-rate and aggregate targets are incompatible
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Result of Targeting Non-Result of Targeting Non-borrowed Reservesborrowed Reserves
• Brief
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Result of Targeting Non-Result of Targeting Non-borrowed Reservesborrowed Reserves
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Result of Targeting Overnight Result of Targeting Overnight FundsFunds
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The Taylor Rule, NAIRU, The Taylor Rule, NAIRU, and the Phillips Curve and the Phillips Curve (brief)(brief)
Overnight interest rate = inflation rate + equilibrium overnight rate + ½ (inflation gap) + ½ (output gap)
• An inflation gap and an output gap– Stabilizing real output is an important concern– Output gap is an indicator of future inflation as
shown by Phillips curve
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• NAIRU– Rate of unemployment at which there is no
tendency for inflation to change