Nothing Special   »   [go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/ulp/sbbeta/2010-19.html
   My bibliography  Save this paper

Financial market imperfections and monetary policy strategy

Author

Listed:
  • Meixing DAI
Abstract
In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank using the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if the access to liquidity is subject to non-price rationing, the central bank can use a narrow monetary aggregate and the discount interest rate as independent policy instruments to reinforce the credibility of its announcements and the role of inflation target as nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman’s k-percent money growth rule, generating dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.

Suggested Citation

  • Meixing DAI, 2010. "Financial market imperfections and monetary policy strategy," Working Papers of BETA 2010-19, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    • Handle: RePEc:ulp:sbbeta:2010-19
    as

    Download full text from publisher

    File URL: http://beta.u-strasbg.fr/WP/2010/2010-19.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Katrin Assenmacher-Wesche & Stefan Gerlach, 2007. "Understanding the Link between Money Growth and Inflation in the Euro Area," Palgrave Macmillan Books, in: David Cobham (ed.), The Travails of the Eurozone, chapter 2, pages 10-41, Palgrave Macmillan.
    2. Lars E. O. Svensson, 2000. "The First Year of the Eurosystem: Inflation Targeting or Not?," American Economic Review, American Economic Association, vol. 90(2), pages 95-99, May.
    3. Michael Woodford, 1998. "Doing Without Money: Controlling Inflation in a Post-Monetary World," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 173-219, January.
    4. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(1), pages 147-180.
    5. Willem H. Buiter & Nikolaos Panigirtzoglou, 2003. "Overcoming the zero bound on nominal interest rates with negative interest on currency: gesell's solution," Economic Journal, Royal Economic Society, vol. 113(490), pages 723-746, October.
    6. Guenter W. Beck & Volker Wieland, 2007. "Money in Monetary Policy Design: A Formal Characterization of ECB-Style Cross-Checking," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 524-533, 04-05.
    7. Carl E. Walsh, 1982. "The effects of alternative operating procedures on economic and financial relationships," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 133-180.
    8. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June.
    9. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Avoiding Liquidity Traps," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 535-563, June.
    10. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    11. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    12. McCallum, Bennett T & Hoehn, James G, 1983. "Instrument Choice for Money Stock Control with Contemporaneous and Lagged Reserve Requirements: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(1), pages 96-101, February.
    13. Alan J. Auerbach & Maurice Obstfeld, 2005. "The Case for Open-Market Purchases in a Liquidity Trap," American Economic Review, American Economic Association, vol. 95(1), pages 110-137, March.
    14. Richard H. Clarida & Mark Gertler, 1997. "How the Bundesbank Conducts Monetary Policy," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 363-412, National Bureau of Economic Research, Inc.
    15. Carl E. Walsh, 2003. "Monetary Theory and Policy, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232316, April.
    16. Michael Woodford, 2008. "How Important Is Money in the Conduct of Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1561-1598, December.
    17. Svensson, Lars-E-O, 2001. "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 277-312, February.
    18. Beck, Günter W. & Wieland, Volker, 2006. "Money in monetary policy design under uncertainty: The two-pillar Phillips curve versus ECB-style cross-checking," CFS Working Paper Series 2007/17, Center for Financial Studies (CFS).
    19. Pierre Dehez, 2013. "Cooperative provision of indivisible public goods," Theory and Decision, Springer, vol. 74(1), pages 13-29, January.
    20. Gertler, Mark & Kiyotaki, Nobuhiro, 2010. "Financial Intermediation and Credit Policy in Business Cycle Analysis," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 11, pages 547-599, Elsevier.
    21. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
    22. Honkapohja, Seppo & Evans, George W., 2003. "Freidman's Money Supply Rule versus Optimal Interest Rate Policy," CEPR Discussion Papers 3883, C.E.P.R. Discussion Papers.
    23. Bernanke, Ben S & Blinder, Alan S, 1988. "Credit, Money, and Aggregate Demand," American Economic Review, American Economic Association, vol. 78(2), pages 435-439, May.
    24. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    25. David Cobham (ed.), 2007. "The Travails of the Eurozone," Palgrave Macmillan Books, Palgrave Macmillan, number 978-0-230-80147-9, December.
    26. Xavier Freixas, 2009. "Monetary policy in a systemic crisis," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 25(4), pages 630-653, Winter.
    27. Julien Jacob & Sandrine Spaeter, 2016. "Large-Scale Risks and Technological Change: What About Limited Liability?," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 18(1), pages 125-142, February.
    28. Gauti B. Eggertsson & Michael Woodford, 2003. "The Zero Bound on Interest Rates and Optimal Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 139-235.
    29. Barthélemy, Jean & Clerc, Laurent & Marx, Magali, 2011. "A two-pillar DSGE monetary policy model for the euro area," Economic Modelling, Elsevier, vol. 28(3), pages 1303-1316, May.
    30. Marc-Hubert Depret & Abdelillah Hamdouch, 2010. "Les clusters et les réseaux comme fondements de la dynamique d'innovation dans l'industrie biopharmaceutique," Working Papers of BETA 2010-11, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    31. Mishkin, Frederic S., 1998. "International Experiences With Different Monetary Policy Regimes," Seminar Papers 648, Stockholm University, Institute for International Economic Studies.
    32. Carl E. Walsh, 2002. "Teaching Inflation Targeting: An Analysis for Intermediate Macro," The Journal of Economic Education, Taylor & Francis Journals, vol. 33(4), pages 333-346, December.
    33. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2007. "Two Reasons Why Money and Credit May be Useful in Monetary Policy," NBER Working Papers 13502, National Bureau of Economic Research, Inc.
    34. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262, National Bureau of Economic Research, Inc.
    35. Francesco Bogliacino & Giulio Perani & Mario Pianta & Stefano Supino, 2010. "Innovation and Development. The Evidence from Innovation Surveys," Working Papers of BETA 2010-13, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    36. Flint Brayton & Gregory D. Hess & David H. Small, 1993. "Nominal income targeting with the monetary base as instrument: an evaluation of McCallum's rule," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
    37. Thomas Laubach & Adam S. Posen, 1997. "Disciplined discretion: the German and Swiss monetary targeting frameworks in operation," Research Paper 9707, Federal Reserve Bank of New York.
    38. Allen, Franklin & Carletti, Elena & Gale, Douglas, 2009. "Interbank market liquidity and central bank intervention," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 639-652, July.
    39. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    40. Kwapil, Claudia & Scharler, Johann, 2010. "Interest rate pass-through, monetary policy rules and macroeconomic stability," Journal of International Money and Finance, Elsevier, vol. 29(2), pages 236-251, March.
    41. George W. Evans & Seppo Honkapohja, 2003. "Friedman's Money Supply Rule vs. Optimal Interest Rate Policy," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 550-566, November.
    42. Gerberding, Christina & Seitz, Franz & Worms, Andreas, 2005. "How the Bundesbank really conducted monetary policy," The North American Journal of Economics and Finance, Elsevier, vol. 16(3), pages 277-292, December.
    43. Benjamin Friedman, 2003. "The LM Curve: A Not-So-Fond Farewell," NBER Working Papers 10123, National Bureau of Economic Research, Inc.
    44. Christian Bordes & Laurent Clerc, 2007. "Price Stability And The Ecb'S Monetary Policy Strategy," Journal of Economic Surveys, Wiley Blackwell, vol. 21(2), pages 268-326, April.
    45. Martin Feldstein & James H. Stock, 1994. "The Use of a Monetary Aggregate to Target Nominal GDP," NBER Chapters, in: Monetary Policy, pages 7-69, National Bureau of Economic Research, Inc.
    46. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
    47. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
    48. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
    49. Rudebusch, Glenn D. & Svensson, Lars E. O., 2002. "Eurosystem monetary targeting: Lessons from U.S. data," European Economic Review, Elsevier, vol. 46(3), pages 417-442, March.
    50. Lawrence Christiano, 2011. "Commentary: Remarks on Unconventional Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 121-130, March.
    51. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-680, May.
    52. Bernanke, Ben S. & Mihov, Ilian, 1997. "What does the Bundesbank target?," European Economic Review, Elsevier, vol. 41(6), pages 1025-1053, June.
    53. Adam, Klaus & Billi, Roberto M., 2007. "Discretionary monetary policy and the zero lower bound on nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 728-752, April.
    54. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
    55. Meixing Dai, 2010. "Financial volatility and optimal instrument choice: A revisit to Poole's analysis," Economics Bulletin, AccessEcon, vol. 30(1), pages 605-613.
    56. Meixing Dai & Moïse Sidiropoulos, 2003. "Règle du taux d’intérêt optimale, prix des actions et taux d’inflation anticipé : une étude de la stabilité macroéconomique," Bulletin de l'Observatoire des politiques économiques en Europe, Observatoire des Politiques Économiques en Europe (OPEE), vol. 0(4), pages 115-140, December.
    57. Ireland, Peter N, 2004. "Money's Role in the Monetary Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(6), pages 969-983, December.
    58. repec:bla:econom:v:71:y:2004:i::p:99-123 is not listed on IDEAS
    59. von Hagen, Jurgen, 1999. "Money growth targeting by the Bundesbank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 681-701, June.
    60. Goodfriend, Marvin, 1983. "Discount window borrowing, monetary policy, and the post-October 6, 1979 federal reserve operating procedure," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 343-356, September.
    61. Carl E. Walsh, 2009. "Using monetary policy to stabilize economic activity," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 245-296.
    62. Paul De Grauwe & Daniel Gros, 2009. "A New Two-Pillar Strategy for the ECB," CESifo Working Paper Series 2818, CESifo.
    63. repec:zbw:bofrdp:2003_010 is not listed on IDEAS
    64. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
    65. Stefan Gerlach, 2004. "The two pillars of the European Central Bank [‘The demand for M3 in the euro area’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 19(40), pages 390-439.
    66. Modigliani, Franco & Rasche, Robert & Cooper, J Philip, 1970. "Central Bank Policy, the Money Supply, and the Short-Term Rate of Interest," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 2(2), pages 166-218, May.
    67. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    68. Liu, Ming-Hua & Margaritis, Dimitri & Tourani-Rad, Alireza, 2008. "Monetary policy transparency and pass-through of retail interest rates," Journal of Banking & Finance, Elsevier, vol. 32(4), pages 501-511, April.
    69. Taylor, John B., 1985. "What would nominal GNP targetting do to the business cycle?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 61-84, January.
    70. Hülsewig, Oliver & Mayer, Eric & Wollmershäuser, Timo, 2009. "Bank behavior, incomplete interest rate pass-through, and the cost channel of monetary policy transmission," Economic Modelling, Elsevier, vol. 26(6), pages 1310-1327, November.
    71. Thomas Mayer, 1987. "U. S. monetary policy," Proceedings, Federal Reserve Bank of San Francisco, pages 201-225.
    72. Teruyoshi Kobayashi, 2008. "Incomplete Interest Rate Pass-Through and Optimal Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 4(3), pages 77-118, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Meixing Dai, 2012. "External Constraint and Financial Crises with Balance Sheet Effects," International Economic Journal, Taylor & Francis Journals, vol. 26(4), pages 567-585, March.
    2. Meixing Dai, 2015. "Les marchés financiers et la politique monétaire de la BCE," Bulletin de l'Observatoire des politiques économiques en Europe, Observatoire des Politiques Économiques en Europe (OPEE), vol. 1, pages 83-119, janvier.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dai, Meixing, 2007. "The design of a ‘two-pillar’ monetary policy strategy," MPRA Paper 14403, University Library of Munich, Germany, revised Mar 2009.
    2. Meixing DAI, 2009. "On the role of money growth targeting under inflation targeting regime," Working Papers of BETA 2009-11, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    3. Meixing DAI, 2007. "A two-pillar strategy to keep inflation expectations at bay: A basic theoretical framework," Working Papers of BETA 2007-20, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    4. Meixing DAI & Moïse SIDIROPOULOS, 2009. "Money growth rule and macro-financial stability under inflation-targeting regime," Working Papers of BETA 2009-05, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    5. Dai, Meixing, 2011. "Quantitative and credit easing policies at the zero lower bound on the nominal interest rate," MPRA Paper 28129, University Library of Munich, Germany.
    6. Wieland, Volker & Binder, Michael & Lieberknecht, Philipp & Quintana, Jorge, 2017. "Model Uncertainty in Macroeconomics: On the Implications of Financial Frictions," CEPR Discussion Papers 12013, C.E.P.R. Discussion Papers.
    7. Glenn D. Rudebusch, 2002. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Economic Journal, Royal Economic Society, vol. 112(479), pages 402-432, April.
    8. Coenen, Gunter & Wieland, Volker, 2005. "A small estimated euro area model with rational expectations and nominal rigidities," European Economic Review, Elsevier, vol. 49(5), pages 1081-1104, July.
    9. Nejla Adanur Aklan & Mehmet Nargelecekenler, 2008. "Taylor Rule in Practice: Evidence from Turkey," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 14(2), pages 156-166, May.
    10. repec:kap:iaecre:v:14:y:2008:i:2:p:156-166 is not listed on IDEAS
    11. Mr. Helge Berger & Mr. Thomas Harjes & Mr. Emil Stavrev, 2008. "The ECB’s Monetary Analysis Revisited," IMF Working Papers 2008/171, International Monetary Fund.
    12. Berger, Helge & Harjes, Thomas & Stavrev, Emil, 2008. "The ECB's monetary analysis revisited," Discussion Papers 2008/14, Free University Berlin, School of Business & Economics.
    13. Wollmershauser, Timo, 2006. "Should central banks react to exchange rate movements? An analysis of the robustness of simple policy rules under exchange rate uncertainty," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 493-519, September.
    14. Beck, Guenter W. & Wieland, Volker, 2008. "Central bank misperceptions and the role of money in interest-rate rules," Journal of Monetary Economics, Elsevier, vol. 55(Supplemen), pages 1-17, October.
    15. Sylvia Staudinger, 2000. "Inflation Targeting versus Nominal Income Targeting," CESifo Working Paper Series 301, CESifo.
    16. Mehrotra, Aaron & Sánchez-Fung, José R., 2011. "Assessing McCallum and Taylor rules in a cross-section of emerging market economies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 21(2), pages 207-228, April.
    17. Castelnuovo, Efrem, 2008. "Regime shifts and the stability of backward-looking Phillips curves in open economies," Journal of International Money and Finance, Elsevier, vol. 27(1), pages 40-53, February.
    18. Giray Gozgor, 2012. "Inflation Targeting and Monetary Policy Rules: Further Evidence from the Case of Turkey," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 2(5), pages 1-7.
    19. Barthélemy, Jean & Clerc, Laurent & Marx, Magali, 2011. "A two-pillar DSGE monetary policy model for the euro area," Economic Modelling, Elsevier, vol. 28(3), pages 1303-1316, May.
    20. Huang, Kevin X.D. & Meng, Qinglai & Xue, Jianpo, 2009. "Is forward-looking inflation targeting destabilizing? The role of policy's response to current output under endogenous investment," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 409-430, February.
    21. Takatoshi Ito & Frederic S. Mishkin, 2006. "Two Decades of Japanese Monetary Policy and the Deflation Problem," NBER Chapters, in: Monetary Policy with Very Low Inflation in the Pacific Rim, pages 131-1997, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Imperfect financial markets; non-price rationing; inflation targeting; monetary targeting; macroeconomic stability; Friedman’s k-percent rule; feedback money growth rules; two-pillar strategy.;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ulp:sbbeta:2010-19. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/bestrfr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.