ECON2004Lecture12

ECON2004Lecture12 - Central banking The number of central...

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Unformatted text preview: Central banking The number of central banks Lecture 12: Modern monetary policy Reading. The Great Inflation Core: Carlin and Soskice Ch 5, section 2; Ch 3, section 2 Optional: Bank of England’s “Framework for monetary policy” www.bankofengland.co.uk/monetarypolicy/framework.htm “Bubble trouble”, The Economist, Sep 2nd 1999 Advanced: Alessina and Summers (1993), “Central bank independence and macroeconomic performance”, Journal of Momey, Credit and Banking 25, 2 Krugman, “Viagra and the Wealth of Nations” ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 1 ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 2 Modern monetary policy Central bank independence • Central bank independence • no political pressures to achieve re-election • Inflation targeting • credibility • Taylor rules • transparency – help the private sector form expectations ….so disinflations are as costless as possible given the Phillips curve ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 3 ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 4 Central bank independence: the evidence Inflation targeting Measures of independence • procedure for appointing governor / committee • are there govt representatives on committee • must CB finance govt deficits? “The Bank's monetary policy objective is to deliver price stability (as defined by the Government's inflation target) and, without prejudice to that objective, to support the Government's economic policy, including its objectives for growth and employment.” (Bank of England) • primary objective: inflation of 2% • symmetrical target: if it deviates by more than 1% from target have to write letter to Chancellor explaining why • secondary objective: output and employment (from Alessina and Summers, 1993) ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 5 ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 6 Why not target zero inflation? How to control inflation? • Downward nominal wage rigidities Individuals are very reluctant to accept cuts in their nominal wage. Therefore the only way to get fall in real wages if unemployment is high is through positive inflation Monetarism: control the money supply (“an intermediate target”) to control inflation BUT relation between money supply and inflation is unstable • Room for manoeuvre The zero lower bound on nominal interest rates Low inflation means low nominal interest rates for any given level of real interest rates. Therefore low inflation reduces ability of central bank to stimulate economy by cutting interest rates. ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 7 So use the short-term interest rate as the policy instrument, and an inflation forecast as the intermediate target. How to choose the interest rate? ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 8 Taylor rules ( ) rt = rs + λ1 π t − π T + λ2 ( y t -y e How to be central banker in four easy steps ) Assess state of economy • Just a description of how central bank behaves but one that seems to work well Yes Is the evolution of the economy likely to be consistent with target? Evaluate likely impact of policy change Implement policy • see Carlin and Soskice, ch 5 section 4.1 to understand the relation between Taylor rules and the MR – PC diagram ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 9 ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 10 The Bank of England’s inflation report The end of (central banking) history? “Since the May Report, the world economy has continued to grow robustly and the price of oil has risen further. In the United Kingdom, output growth over the past year is now estimated to have fallen below trend. Household spending and business investment were reported to be broadly flat in Q1, but public expenditure grew robustly. Market interest rates declined, sterling depreciated and equity prices rose. Labour cost pressures remained contained, but input price inflation moved higher. CPI inflation edged up to meet the 2% target. In the Committee’s central projection under the assumption that official interest rates follow a path implied by market yields, GDP growth remains a little below trend in the near term, but thereafter picks up as the influence of recent movements in asset prices is felt…… The risks to growth and inflation are weighted slightly to the downside.” • What to do about asset price bubbles? • “risk management” a la Greenspan, or rigid inflation targetting • The credit crunch ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 11 ECON2004 Macro Term 1, Lecture 12: Modern monetary policy 12 ...
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This note was uploaded on 05/25/2011 for the course ECON 2004 taught by Professor L during the Spring '11 term at UCL.

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