Download Central Banks - The Swiss Global Economics

Monetary Policy After the Crisis
Challenges & Policy Responses
September 2010
Background
 The Great Recession and the financial crisis that
marked its emergence put in check a lot of the
consensus that MP had achieved
 The crisis and emergency policy response that
followed raised three policy questions:
 What are the effects of unorthodox tools when the interest rate
cannot be used as the main instrument?
 What Should The Central Bank main focus be to get back on a
solid footing recovery
 What should be the right level of inflation
 What is next for Monetary Policy
The Role for Monetary Policy
• Changes in money supply M
The LM curve is drawn for a given supply of money
M/P = L(r,Y)
• The Central Bank can directly affect that supply
Increase in M  r falls
Shift of LM curve
• The Central Bank can also set interest rates
• A monetary policy change affects interest Rates for
any Y with the spill over effects in the goods
market
The Role for Monetary Policy
r
Shape of LM will
depend on how CB
sets its policy
LM
r
r1
1
L(Y2)
L(Y1 )
M/P
M/P
The Central Bank commits to setting M at
whatever level is necessary to sustain r1 in the
money market
Y
Quantitative Easing: Major Players, Basic Elements
Central Banks
 Expanding the amount of money in the
economy
 Expanding the balance sheet of
the Central Bank
R at 0
$
trillions
reserve
Assets
Banks
Bonds
Yields
Companies
Households
Bonds
Price
Quantitative Easing: How It works
•
•
•
•
•
•
The Central Bank buys Government bonds
The extra demand raises bond prices and lower their yields
Lower long-term interest rates stimulate economic activities.
Banks sell their bonds to the Central bank creating reserves in return
Banks swap low-yielding reserves for better return shares or corporate debt.
This lowers private-borrowing costs and raises asset values, boosting wealth
and spending
Does it work?
• No guarantee that banks will lend or that companies or household will borrow
• The Bank of Japan five-years of QE in the early 2000s had barely any effect on
inflation and unemployment
• The Federal Reserve Policy of QE that bought $1.75 trillion of Treasuries and
mortgage-related debt, bringing long-term interest rates down sharply had
barely any effect on bank credit .
The Risk Of QE
•
•
•
•
•
Central Bank can loose money
Danger of Inflation
Potential to destroy confidence in an Economy
May not work if not implemented aggressively enough
Difficult to gauge how much QE is needed
Quantitative Easing: Assessing The Effects
Asset Bubbles
• The consensus view, embodied in the Taylor Rule, was that the CB should only look at
inflation and prices
• But this could contribute to asset price “bubbles” (i.e. unsustainable price increases)
• It follows that even when inflation (of goods and services) is low, there could be asset
price inflation indicating that the economy is overheating
 The Central Bank could raise interest rates, even if inflation is low, when they perceive a
bubble in asset prices
• But when do you know it’s a bubble, as opposed to a sustainable increase in prices?
• Should interest rates be the instrument to “prick” those bubbles?
 The CB is typically also the regulator of financial markets…  “Macroprudential
regulation”
Inflation: Rethinking The Right Target
• Low inflation implies low nominal interest rates
• If interest rates are low when a crisis hit, it is more likely that MP
will hit the zero rate lower bound.
• Deflation should be avoided because it depresses spending, and
thus creates a vicious circle
• Fighting inflation is very important to ensure both the credibilty
of The Central Bank and the effectiveness of monetary policy .
Interest Rates: Forecasting The Outlook
The U.S.
Given the uncertainty about the recovery and the fear for a double-dip recession, the Fed is
likely to keep interest rates at «Exceptionally low» levels for an extended period of at least 6
months
Canada
Recent emerging signs of accelerating inflation and the Canadian dollar climbing to parity
with the US Dollar, has led some economists to predict an earlier rate hike.
Eurozone
With both growth and inflation remaining moderate, The ECB is focused on gradually
withdrawing the exceptional steps it took to prop-up the financial sector
China
The People’s Bank of China has been adopting a wait-and-see approach before
developping the «heavy-duty weapon» of interest rate hikes. But with Consumer Inflation
rising to 2 .8% and the benchmark one-year deposit rate at just 2.5%, there is an increasing
likelihood of a r
Te hike in the coming months.
Japan
With deflation and rates at 0.1%, the BoJ has been under pressure to take further action.
The Bank recently increased a programme of three-month 0.1% loans to Commercial Banks
from Y 10,000 to Y 20,000 bn, but is resisting calls for it to buy Government bonds or other
assets. Rates are likely to remain close to zero for at least a year.
Australia
Central Banks: The need for readjustment
Policy Prescriptions
• QE need to be combined with looser fiscal policy to
stimulate private demand
• The governmnt should step in to boost spending by
borrowing to cut taxes; send cheques to households;
build Infrastructure; and if necessary extinguish
underwater mortgages
• Create fiscal institutions that mimic the rigour and
autonomy of Central Banks that will help the
governments to commit to a target debt-to –GDP ratio.