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Monetary Policy A Theoretical and Econometric Approach

This website is owned by Stephen G Cecchetti and Kermit L Schoenholtz. It contains both our commentary on current economic and financial conditions and material intended to aid students and instructors using our textbook, Money, Banking and Financial Markets, 9th edition, 7569. “It is only a matter of time before another cyclical downturn calls for aggressive negative nominal interest rate policy actions. Hope for the best, but prepare for the worst. That could be the motto of any risk manager. In the case of a central banker, the job of ensuring low, stable inflation and high, stable growth requires constant contingency planning.

Monetary Policy in Nigeria ArticlesNG

With the global economy humming along, monetary policymakers are on track to normalize policy. While that process is hardly free of risk, their bigger test will be how to address the next cyclical downturn whenever it arrives. Will policymakers have the tools needed to stabilize prices and ensure steady expansion? Because the equilibrium level of interest rates is substantially lower, the scope for conventional interest rate cuts is smaller. As a result, the challenge is bigger than it was in the past. I d like to thank the European Central Bank (ECB), both for inviting me to give this keynote address and for organizing this conference on money markets, monetary policy implementation, and central bank balance sheets.

I d also like to congratulate all of the presenters and discussants, whose engaging research and critiques help to foster a deeper understanding of some of the many policy implementation issues central bankers face as we digest past challenges and prepare for future ones. 6 I would like to thank Deborah Leonard for her assistance in the preparation of these remarks, and colleagues in the Federal Reserve System for numerous insightful comments and suggestions. 7 My discussion here focuses on the Federal Reserve s actions to adjust the stance and conduct of monetary policy in pursuit of its statutory mandate of full employment and price stability. However, the also included numerous temporary programs and facilities aimed at supporting the liquidity of financial institutions and fostering improved conditions in key financial markets. 8 The Fed s outright purchases of securities did not raise any credit risk exposure. 9 The FOMC also undertook a program to extend the maturity profile of its Treasury holdings.

The Evolution of U S Monetary Policy 2000 2007

This Maturity Extension Program (MEP) did not affect the portfolio s overall size, yet still increased the portfolio s duration risk—an important characteristic of all asset purchase programs. A common metric for communicating about the dollar value of duration risk held in the portfolio is in terms of ten-year Treasury equivalents. Rapidly rising prices (inflation) reduce purchasing power (especially among poor people who have fewer opportunities to diversity to other assets) while disrupting economic activity. Inflation is a monetary phenomenon because rising/falling prices can only ultimately be sustained if accompanied by monetary expansion/contraction. Thus, it is appropriate that control of inflation is a primary concern of monetary policy. Essentially, monetary policy involves influencing the demand and supply of money, through controlling either the quantity of money in circulation or its price (the interest rate).

The transmission mechanism of monetary policy remains only partially understood, reflecting both the underlying complexity and its nature varying across economies as well as its evolution (sometimes rapidly) over time. In recent years, the prevailing consensus among economists regarding monetary policy is based on a number of key propositions regarding both theory and practice. Often referred to as the New Consensus', this refers to previous disputes over the proper role of monetary policy, such as that between the Keynesians' and the Monetarists' that divided economists from the 6965s to the 6995s. Based on this consensus, since the early 6995s there has been a clear trend for national authorities to adopt a framework for monetary policy based on the following key elements: Within this general trend, some central banks have formally adopted a framework of inflation targeting (IT). This entails a binding to conduct monetary policy with the aim of achieving a numerically specified target level (or range) of inflation within a specified time period, and where the central bank is held accountable for meeting the inflation target.

Typically, the target is defined by the government as a means of ensuring democratic accountability for the policy, while the central bank is guaranteed independence to pursue this mandate without interference. The means of accountability (such as publishing the minutes of meetings where policy decisions are taken), as well as the consequences for failing to meet the target are also clearly established. In practice, IT also places great emphasis on aligning the policy stance with the medium-term forecast of inflation, with the forecast effectively assuming the role of intermediate target in the IT framework.