Mishkin PPT Ch16

Chapter 16
The Conduct of
Monetary Policy:
Strategy and
Tactics
Copyright 2010 Pearson Addison-Wesley. All rights reserved.
Monetary Targeting I
United States
Fed began to announce publicly targets for
money supply growth in 1975.
Paul Volker (1979) focused more in nonborrowed
reserves
Greenspan announced in July 1993 that the Fed
would not use any monetary aggregates as a
guide for conducting monetary policy
16-2
Monetary Targeting II
Japan
In 1978 the Bank of Japan began to announce
forecasts for M2 + CDs
Bank of Japans monetary performance was
much better than the Feds during 1978-1987.
In 1989 the Bank of Japan switched to a tighter
monetary policy and was partially blamed for the
lost decade
16-3
Monetary Targeting III

Germany
The Bundesbank focused on central bank
money in the early 1970s.
A monetary targeting regime can restrain
inflation in the longer run, even when targets
are missed.
The reason of the relative success despite
missing targets relies on clearly stated
monetary policy objectives and central bank
engagement in communication with the public.
16-4
Monetary 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
16-5
Inflation Targeting I
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
16-6
Inflation Targeting II
New Zealand (effective in 1990)
Inflation was brought down and remained within the
target most of the time.
Growth has generally been high and unemployment has
come down significantly
Canada (1991)
Inflation decreased since then, some costs in term of
unemployment
United Kingdom (1992)

Inflation has been close to its target.
Growth has been strong and unemployment has been
decreasing.
16-7
Inflation Targeting III

Advantages
Does not rely on one variable to achieve target
Easily understood
Reduces potential of falling in timeinconsistency trap
Stresses transparency and accountability
Disadvantages
Delayed signaling
Too much rigidity
Potential for increased output fluctuations
Low economic growth during disinflation
16-8
FIGURE 1 Inflation Rates and Inflation Targets

for New Zealand, Canada, and the United
Kingdom, 19802008
Source: Ben S. Bernanke,

Thomas Laubach, Frederic S.
Mishkin, and Adam S. Poson,
Inflation Targeting: Lessons
from the International
Experience (Princeton: Princeton
University Press, 1999), updates
from the same sources, and
www.rbnz.govt
.nz/statistics/econind/a3/ha3.xls
.
16-9
Monetary Policy with an

Implicit Nominal Anchor
There is no explicit nominal anchor in the
form of an overriding concern for the Fed.
Forward looking behavior and periodic
preemptive strikes
The goal is to prevent inflation from getting
started.
16-10
Monetary Policy with an

Implicit Nominal Anchor II
Advantages
Uses many sources of information
Avoids time-inconsistency problem
Demonstrated success
Disadvantages
Lack of transparency and accountability
Strong dependence on the preferences, skills, and
trustworthiness of individuals in charge
Inconsistent with democratic principles
16-11
Summary Table 1 Advantages and

Disadvantages of Different Monetary Policy
Strategies
16-12
Tactics: Choosing the Policy

Instrument
Tools
Open market operation
Reserve requirements
Discount rate
Policy instrument (operating instrument)

Reserve aggregates
Interest rates
May be linked to an intermediate target
Interest-rate and aggregate targets are

incompatible (must chose one or the other).
16-13
FIGURE 2 Linkages Between Central Bank Tools,

Policy Instruments, Intermediate Targets, and Goals
of Monetary Policy
16-14
FIGURE 3 Result of Targeting on

Nonborrowed Reserves
16-15
Criteria for Choosing the

Policy Instrument
Observability and Measurability
Controllability
Predictable effect on Goals
16-16
The Taylor Rule, NAIRU, and

the Phillips Curve
Federal funds rate target =
inflation rate

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
NAIRU
Rate of unemployment at which there is no tendency for
inflation to change
16-17
FIGURE 4 Result of Targeting on

the Federal Funds Rate
16-18
Central Banks Response to Asset Price

Bubbles: Lessons From the Subprime
Crisis
Asset-price bubble: pronounced increase in

asset prices that depart from fundamental
values, which eventually burst.
Types of asset-price bubbles
Credit-driven bubbles
Subprime financial crisis
Bubbles driven solely by irrational exuberance
16-19

Crisis
Should central banks respond to bubbles?

Strong argument for not responding to bubbles
driven by irrational exuberance
Bubbles are easier to identify when asset prices
and credit are increasing rapidly at the same
time.
Monetary policy should not be used to prick
bubbles.
16-20

Crisis
Macropudential regulation: regulatory policy

to affect what is happening in credit
markets in the aggregate.
Central banks and other regulators should
not have a laissez-faire attitude and let
credit-driven bubbles proceed without any
reaction.
16-21
Historical Perspective I
Discount policy and the real bills doctrine
Discovery of open market operations
The Great Depression
Reserve requirements as a policy tool
Thomas Amendment to the Agricultural Adjustment Act of
1933
War finance and the pegging of interest rates
16-22
Historical Perspective II
Targeting money market conditions
Procyclical monetary policy
Targeting monetary aggregates

New Fed operating procedures
De-emphasis of federal funds rate
De-emphasis of monetary aggregates

Borrowed reserves target
Federal funds targeting again

Greater transparency
16-23
Historical Perspective III

Preemptive strikes against inflation
Preemptive strikes against economic
downturns and financial disruptions
LTCM
Enron
Subprime meltdown
International policy coordination
16-24
FIGURE 5 The Taylor Rule for the

Federal Funds Rate, 19702008
Source: Federal Reserve: www.federalreserve.gov/releases and authors calculations.

16-25

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Chapter 16

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Monetary Targeting III

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

United Kingdom (1992)

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Inflation Targeting III

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

FIGURE 1 Inflation Rates and Inflation Targets

Source: Ben S. Bernanke,

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Monetary Policy with an

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Monetary Policy with an

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Summary Table 1 Advantages and

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Tactics: Choosing the Policy

Policy instrument (operating instrument)

Interest-rate and aggregate targets are

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

FIGURE 2 Linkages Between Central Bank Tools,

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

FIGURE 3 Result of Targeting on

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Criteria for Choosing the

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

The Taylor Rule, NAIRU, and

FIGURE 4 Result of Targeting on

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Central Banks Response to Asset Price

Asset-price bubble: pronounced increase in

Bubbles driven solely by irrational exuberance

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Central Banks Response to Asset Price

Should central banks respond to bubbles?

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Central Banks Response to Asset Price

Macropudential regulation: regulatory policy

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

War finance and the pegging of interest rates

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

Targeting monetary aggregates

De-emphasis of monetary aggregates

Federal funds targeting again

Historical Perspective III

International policy coordination

Copyright 2010 Pearson Addison-Wesley. All rights reserved.

FIGURE 5 The Taylor Rule for the

Source: Federal Reserve: www.federalreserve.gov/releases and authors calculations.

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