Monetary policy

The monetary policy is the action by which the monetary authority, in general the Central bank, acts on the offer of currency with an aim of filling its objective of price stability. It also stains to achieve the other goals of the Economic policy: the growth, the full employment, the external balance. The monetary policy is distinguished from the Budget policy .

Objectives of the monetary policy

The consequences of the monetary policy are very broad: they relate to the price level like on the level of activity. The objective of the monetary policy is to contribute to the safeguard of the internal and external value of the national currency, requirement for a price stability. The control of the company on the monetary authority is expressed through the objectives which are assigned with its policy, like on control a posteriori whose it is the object.

Various types of monetary policy

Fixity of foreign exchange rates

The monetary policy can aim to maintain the Foreign exchange rate national currency with a currency or a basket of currencies. The fixity of foreign exchange rates can be obtained by the Central bank while selling or by buying currencies from day to day to reach the objective rate. In a certain manner, the central bank gives up the independence of its monetary policy: it is subjected to the triangle of the incompatibilities. The China, for example, adopted a policy of maintenance of the fixity of the exchanges with a basket of currencies.

The Étalon-or, which consists in maintaining the parity of the currency with gold constant, can be regarded as a particular case of fixity of foreign exchange rates. It is used any more by no country since 1971.

The “currency board” is another particular case of the fixity of foreign exchange rates. In this extreme case, the central bank completely leans its currency on another currency, generally the dollar or another currency considered as stable. The central bank preserves a unit of the currency of anchoring for each unit of national currency in circulation: it does not lay out any more a any latitude to follow a policy adapted to the needs for the nation's economy. This solution makes it possible “to import” the credibility of the foreign currency: the currency board are often set up following episodes of Hyperinflation. Currently, Hong-Kong and Bulgaria function under this mode. The Argentine gave up this policy following a monetary crisis in 2002.

Targeting of the growth of the monetary aggregates

Following the development of the Monétarisme in the years 1970, certain countries adopted a monetary policy based on a targeting of the growth of the monetary aggregates. The money Supply, from a point of view monetarist, must grow at the same rate/rhythm as the national product. If the money supply is under control, then inflation is stable.

This policy was adopted by Paul Volcker in the United States at the beginning of its mandate, then was quickly abandoned. It today is seldom implemented: indeed, it mechanically implies a very great volatility of interest rates.

Targeting of inflation

The targeting of inflation is a policy aiming at maintaining inflation close to an objective. Explicit bands of fluctuation of inflation can be installation by the central bank.

Since the end of the year 1980, a consensus was gradually set up in favor of the targeting of inflation, in order to limit the growth then excessive of the prices. According to recognized economists, such as F. Mishkin or Ben Bernake this policy was crowned success. At present, a crescents number of countries chose to adopt a monetary policy of targeting of inflation: News Zealand, Canada, the United Kingdom, and more recently various countries of South America and many Central European countries and Eastern. Concerning the two large United States world powers and European Union, they explicitly does not practice a policy of targeting of inflation. However one can think that the United States will move towards this kind of policy since the new governor of the EDF, Ben Bernake, is a large defender of the policies of targeting of inflation. The use of the targeting of inflation rests on two main arguments:

According to the new traditional macroeconomics, the withdrawn benefit of an expansionist monetary policy are only transitory, whereas the consequences in term of inflation are durable. Consequently, it is adapted to follow noninflationary monetary policies. Insofar as an engagement of the government in this direction is not credible (since nonirreversible), it is necessary that the central bank is independent to counter inflationary anticipations. Barro and Gordons showed in an article of 1982 the interest of independence for the effectiveness of the monetary policies.
Insofar as anticipations play a fundamental role in the fixing of the prices, it is important that the central bank is credible in its will to limit inflation. The use of a target of inflation makes it possible the public to simply judge the effectiveness of the Monetary authorities. The central bank, more credible, sees the effectiveness of its reinforced policy. This reasoning binding rules and credibility was developed by Kydland and Prescott in an article of 1977.

Tools of the monetary policies

One with the practice to distinguish four levels within the devices set up by the monetary policies: final objectives, objectives intermediaries, indicators and instruments:

Objectives

the final objectives are the ultimate goals followed by the monetary policy (price stability or nominal GDP for example). The monetary policy cannot have these aims directly because the central banks have only one very indirect control of these economic sizes, which react with shifts rather long and variable to the impulses of the monetary policy, and are observed only with one important delay and spaced an enough periodicity.
the intermediate objectives, like the aggregates of the currency or foreign exchange rates, are thus set up. These intermediate targets do not have a value in themselves, if it is not their correlation with the final goals with which they maintain a causal relation. They better controllable and are more quickly observed that the ultimate objectives.

Indicators

the advanced indicators are economic variables which provide to the central bank of information on the state of the economy (typically: inflationary pressures or anticipations or effective orientation of the monetary policy, the degree of its expansive or restrictive nature).

Instruments

Sometimes called “operational objectives”, in fact variables are directly under the control of the central bank. The choice of the instruments and the rules defined to handle them determine the monetary policy from day to day. There exist two principal means of action for the central bank:

the action on the banking liquidity, by which the central bank acts on the banks second-rate by more or less feeding them in currency, and modifying the rate of the obligatory reserves.
the action on the rates, where the central bank plays on the three directing Taux S which it controls (Taux of facility of marginal loan, Taux of facility of deposit, Opérations open market). The variations of these rates modify the behavior of the banks second-rate.

The majority of the central banks choose short-term interest rate like instrument. It is the only rate which a central bank can control indeed in a precise way. Indeed, the credits of very short term are very close to the currency (liquidity), and the central bank has a monopoly for the emission of currency. By controlling short-term interest rates, the central bank has a strong influence on the offer of liquidity. On the other hand, as maturity increases, the rates incorporate anticipations of the market and thus escape control from the central bank.

See too

Internal bonds

External bonds

Political monetary economic-Policy

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