Monetary Policy: Central Bank Independence and Inflation Targeting Flashcards
Objectives of the ECB
“The primary objective of the ECB is the maintenance of price stability”
ECB political independence statement
“The ECB (…) shall not seek nor take instructions from Community institutions or bodies, from any Government of a Member State or from any other body”.
What is the Barro-Gordon Model?
The ability of government to manipulate output would lead to an inflationary bias.
Gov able to force U below the natural rate. LR worse off.
What are the key implications of NAIRU and time inconsistency.
NAIRU: LR lower inflation can be achieved without increasing unemployment/lower output.
Time inconsistency: politicians would be unable to credible deliver lower inflation.
Trends of inflation and CB independence (1950s to 1980s)
Negative relationship, greater the independence the lower the inflation.
Spain (inflation: 8.5%, CBI: 1.5)
Germany (inflation: 3%, CBI: 4)
Trends of inflation and CB independence (1950s to 1980s)
Negative relationship, greater the independence the lower the inflation.
Spain (inflation: 8.5%, CBI: 1.5)
Germany (inflation: 3%, CBI: 4)
Trends of inflation and CB independence (2000 to 2008)
Little correlation between the two variables.
Anastasiou (2009)
Central Bank Independence
• Independence associated with lower inflation. No
significant relationship between growth or unemployment.
Outline the new possible problem.
A temporary increase in unemployment.
ECB interprets as increase in NAIRU and increase its target unemployment rate.
ECB will not attempt stabilization after shift to the right.
ECB behaves as super-conservative
by attaching a zero weight to
unemployment stabilization.
ECB (2003)
“the outlook for the euro area economy could
be significantly improved if governments
strengthen their efforts to implement structural
reforms in labour and product markets.”
Khan and Senhadji (2001)
Inflation rates
above a threshold around 3 % have a negative
impact on growth
Akerlof et al (1996)
Estimated that
lowering inflation in the US from 3 to 0 % would
lead to persistent higher unemployment and lower
output.
Keynes: deflation
‘pushing on a piece of string’
Expected falling prices make
postponing consumption rational; ‘debt deflation’ – raises burden on borrowers → increased bankruptcy risk.
Bernanke: inflation and CBI
‘Careful empirical studies support the view that more independent central banks tend to deliver better inflation outcomes than less-independent central banks, without compromising economic growth.’
What is inflation targeting?
A target for inflation is set. Monetary policy (mainly interest rates) set to achieve this implemented by ICB. IT credibly delivers low and stable inflation, anchors expectations of low inflation even with shocks.
Bernanke (2003)
“this discretion of
policy makers is constrained by a strong commitment to keeping inflation low
and stable.”
Andersen et al. (2015)
Economic activity is stable around NAIRU.
No LR trade off between unemployment and inflation.
Instabilities in the money supply make IT superior to money supply targeting.
Fixed exchange rate regimes vulnerable to speculative attack.
Little or no role for active fiscal policy.
Velocity of Circulation Trends (USA)
Stable increase to peak in mid 1990s and then steep fall, made steeper following the GFC in 2008.
Mishkin (1997)
CB minimizing some loss function. Allows for lagged adjustment from sticky pries and forward looking behavior.
Delivers lower inflation without lower output growth or
higher unemployment in the medium run.
Evaluation: Ball and
Sheridan (2004)
Trends of headline and core inflation in the Euro Area
Core HICP follows stable trend ranging from 0.5 to 2%.
All-items HICP range alot more from 4% to -0.75%, deflation following GFC.
US inflation trades trend (Bureau of Economic Analysis for inflation, Bureau of Labor Statistics for the unemployment rate)
From the end of 2014 onwards there has been a steady increase in the inflation rate of both the core and overall index.
From 2014 onwards a steady decrease in the unemployment rate from 6.5% to 3.5%.
Andersen et al (2015)
Post Crisis testing
Grwth = IT dummy varible, GAP (output gap), PY (potential growth in previous decade), DEBT (public debt to GDp ratio), PR (housing price to rent ratio, time dummy and error term.
Results indite higher growth in IT regimes.
Evaluation of Anderson et al (2015) Post Crisis Testing
Output gap: varied widely, element of judgement involved.
Showed limited responsiveness of investment and consumption to interest rates.
Frankel (2012) Real supply side shocks and terms of trade shocks lead
to arguably inappropriate policy response. raising
interest rates before 2008 financial crisis.
HM Treasury (2019)
Found large range of estimates of UK output gap ranging from -1% to 1% in 2019.
