The Future of U.S. Monetary Policy

Transcription

1 The Future of U.S. Monetary Policy Greenspan to Bernanke Andrew Bragg

2 Outline What is Monetary Policy? How should Monetary Policy be Achieved? Credibility and the Central Banker Does the Person in Charge Matter? Monetary Policy under Alan Greenspan Ben Bernanke s Anticipated Policies How the Two Central Bankers Differ What will Future US Monetary Policy be?

3 Monetary Policy Coupled with Fiscal Policy, is one of the main tools used to influence macroecomic behaviour Uses the overnight interest rate, open-market purchases, exchange fund account Changes in the money supply can affect: Classical: price levels, nominal exchange rate Keynesian: real GDP, real interest rate, unemployment rate

4 How the Money Supply is Determined The actual money supply is a function of the monetary base and the money multiplier M = Where cu cu res cu = publicly held currency res = bank reserves BASE

5 Effect of Shifts in the LM Curve LM 2 By shifting the LM curve (through the money supply) the central bank can shift the economy back towards its fullemployment production level In a large open economy, the effect of changing the money supply is on the interest rates r* and not the exchange rates in the economy LM* LM 1 IS Y*

6 Goals of Monetary Policy Low and stable inflation, high economic growth, low unemployment Abel, Bernanke and Smith

7 General Approaches to Monetary Policy In the long run, the only effect of the money supply is on inflation rates, but in the short term there are two differing approaches: Keynesian Central Bank should be able to operate fairly freely to influence the money supply (and smooth cyclicality) Monetarists No discretion should be allowed (cannot smooth business cycles) Instead, money supply changes should be formulaic in their approach

8 Credibility and Monetary Policy If the central bank wants to keep inflation low, it can promise to keep the money supply constant However firms will raise their prices (inflation) As the central bank does not want to go into a recession (at a point less than Y), it will increase the money supply anyway How does the central bank create credibility?

9 Credibility and Monetary Policy How does the central bank create credibility? Tie its hands so that it has no discretion over monetary policy (monetarists) Have a central banker in place who is credible with their threats and is strict with their policies Individuals in society must believe that stated future policies are true future policies

10 Does it matter who is in charge? A paper by David Hakes addressed this issue Found that monetary policy reaction functions between Volcker ( ) and Martin ( ) were strikingly similar P = b + b IP + b PPI + b U + b BT + t 0 1 t 2 where P = policy indicator tight money = 0, easy money = 1 IP = growth indicator (industrial production) PPI = inflation indicator (producer price index U = unemployment indicator BT = balance of trade surplus t 3 t 4 4 e t Source: Hakes, David R. The Objectives and Priorities of Monetary Policy under Different Federal Reserve Chairmen. Journal of Money, Credit and Banking, Vol. 22, No. 3 (Aug., 1990) p

11 Does it matter who is in charge? However, The reaction function for Burns tenure ( ) was vastly different than the other two Was too small of a sample used? Were the correct variables assessed? Even with adjusting for the effect of different Presidents (who can influence monetary policy through fiscal policy, appointments), the chairman in power had a significant effect at the 1% level Although the paper did not assess Greenspan s tenure, one can see that he has been the continuity bridging US Monetary Policy over four presidential campaigns

12 Alan Greenspan s Legacy 18 ½ years of service as the chairman of the Federal Reserve Coined the phrase irrational exuberance Lasted through 4 presidential terms (Reagan, Bush, Clinton, Bush) 1987 crash, 1991 recession, late 1990 s Asian market crisis, tech boom and bust, and the current real estate boom Seen by some as the greatest central banker in U.S. history

13 Greenspan s Policies Inflation fighter More by feel for condition of the economy than targets Against set unemployment targets, GDP growth rates Would allow the economy to roam a bit Staunch promoter of Fed independence Tightened monetary policy during many reelection campaigns Comments on the stock market and other asset prices (over or undervalued) were unprecedented territory for the Fed Became an individual who could move markets through speech

14 Greenspan s Policies Conservative policies err more on the side of restrictiveness than stimulus 1 Against large government deficits Harder to use monetary policy, as long-term rates don t adjust to short-term changes as well Personal objection to antitrust laws Promoter of deregulation Seen as a brilliant, if sometimes bewildering, orator I know you believe you understand what you think I said, but I am not sure you realize that what you heard is not what I meant 1 1 Martin, Justin. Greenspan: The Man Behind Money. Cambridge: Perseus Publishing, 2000.

15 Ben Bernanke Nominated by President Bush as Greenspan s successor (Oct. 24, 2005) Current Chairman of the President s Council of Economic Advisors Board of Governors of US Federal Reserve Princeton economics professor Generally seen as the safest among the current candidates (good for economic stabilization in the short term) Major weakness is his lack of experience has been an academic for most of his career

16 How Bernanke differs from Greenspan Inflation targeting Adjustment of the interest rate to keep projected inflation in-line with a predetermined target (due to time lag with monetary policy) Still have discretion within the band Ideal target is 2-3% Canada, UK, Sweden, New Zealand, Finland, Australia, Israel, Spain Increasing the transparency of monetary policy Easier for the public to understand and decipher changes Asset Pricing Changes in asset prices should affect monetary policy only to the extent that they affect the central bank s forecast of inflation 1 1 Bernanke, Ben & Gertler, Mark. Should Central Banks Respond to Movements in Asset Prices? The American Economic Review. Vol. 91, No. 2 (May, 2001) p

17 Projected Monetary Policy Short-term Bernanke will probably follow Greenspan s implemented policies Need to continue the confidence in the credibility and independence of the Federal Reserve US is currently in a period of general instability (stocks have retreated from recent highs, volatility of oil prices) a change in investor confidence could send the US (and world) stock markets tumbling My first priority will be to maintain continuity with the policies and policy strategies established during the Greenspan years Oct. 25, 2005

18 Projected Monetary Policy Long-term Not much of a difference can only operate within a narrow band of policy options Criticizing as a third party vs. following through as the Chairman Possible move towards inflation targeting (must change Federal Reserve rules for this to happen) Bernanke may be pressured to start responding to asset prices (i.e. the stock market)

19 Sources Abel, Bernanke & Smith. Macroeconomics, 3 rd ed. Toronto: Pearson Education, Balls, Andrew. Advent of inflation targeting disciple, Financial Times, 25 October 2005, 1. Balls, Andrew and Alden, Edward. Bernanke set for top job at Fed, Financial Times, 25 October 2005, 1. Bernanke, Ben & Gertler, Mark. Should Central Banks Respond to Movements in Asset Prices? The American Economic Review. Vol. 91, No. 2 (May, 2001) p Bernanke, Ben & Mishkin, Frederic. Inflation Targeting: A New Framework for Monetary Policy? The Journal of Economic Perspectives. Vol. 11, No. 2 (Spring, 1997) p Corcoran, Terence. It s not good enough to stay the course: Greenspan created the rough waters he sailed through National Post, 25 October FP1. Hakes, David R. The Objectives and Priorities of Monetary Policy under Different Federal Reserve Chairmen Journal of Money, Credit and Banking, Vol. 22, No. 3 (Aug., 1990) p Mankiw & Scratch. Macroeconomics: Canadian Edition. 2 nd ed. New York: Worth Publishers, Martin, Justin. Greenspan: The Man Behind Money. Cambridge: Perseus Publishing, 2000.