Archive for March 23rd, 2009

Summary of Japan’s woes in crisis – 2007-?

March 23, 2009

IMF has started a new series of policy research papers- Staff Position Notes. Each of the papers are worth reading as they are contemporary and simple to read. The papers have been widely discussed as well. The first paperis a look at fiscal policy to solve the crisis, second one raises deflation risks for Japan and US, Fourth one is IMF’s case for a global fiscal stimulus etc etc.

The recent paper (6th in the series) is a nice brief on why Japan has been hit so hard because of the global crisis.

  • Trade Channel: It is mainly because Japan has been export driven. Japanese exports are advanced manufactured products like cars, IT, machinery ets. As global economy slumped, so did demand for Japanese exports.
  • Finance Channel: The global financial crisis led to concerns at Japanese fin markets as well leading to worsening of trade channel

This is all pretty well known. However, the paper has numerous graphs to tell the story. The first chart is particularly interesting. It plots the GDP growth with share of high tech exports as a % of GDP. The result is quite starking. The economies that have higher share of high tech exports as a % of GDP show the highest decline in their GDP as well (Korea, Taiwan, Japan etc).

A review of Bundesbank monetary targeting strategy

March 23, 2009

Manfred Neumann (Univ of Bonn) has written a nice overview of Bundesbank’s (Germany Central bank) monetary targeting strategy (see this paper as well). The overview was presented at ECB colloquium held in honour of Otmar Issing.

Neumann begins by presenting the background on why monetary targeting was adopted:

The background to the adoption of monetary targeting was the systemic need for a reorientation of monetary policy after the break-down of the Bretton-Woods-System.

The move to flexible exchange rates freed monetary policy from having to stabilise the exchange rate vis-á-vis the dollar and provided central banks with the potency of controlling domestic money and credit creation. However, along with this potency goes the burden of responsibility for securing domestic price stability. It is not easy to fulfil this task successfully because the absence of a binding exchange rate constraint implies that monetary policy is not anchored anymore.

In the mid-1970s this analysis was not known, of course. Nevertheless, quite a few central bankers in Germany and, by the way, in Switzerland appeared to understand that the regime change from fixed to floating rates required a new policy strategy in order to be able to check inflation expectations. They concluded that it would be useful, if not necessary, to commit to some type of rule that credibly constrains monetary policy.

The historic opportunity to start monetary targeting came in 1974 when, due to the quadrupling of the oil price and a sharp monetary deceleration, the German economy began to cool down. The Bundesbank wanted to switch towards easing without giving labour unions a signal for higher wage demands. Announcing a monetary target appeared to be the solution.

He then touches brief on the type of targets – point target, annual average, range (planned growth rate of money stock looking at growth of this quarter over previous quarter).

He then points that monetary targets were missed quite a few times  (1976,1977, 1978, 1986, 1987 and 1992). In all the years reason for missing the target was exchange rate considerations. 

To sum up this brief review of historic cases: the largest misses of monetary targets were caused by the Bundesbank’s temporary subordination of monetary policy to exchange rate considerations either with respect to the dollar or/and with respect to EMS-currencies. An exception was 1986 when the Bank went for reflation but avoided a consistent increase of the target range.

 So much so, debates were held whether to continue with monetary targeting or not.

Despite the misses, Bundesbank had an excellent inflation control record compared to other economies. However, the puzzle remained

But isn’t this a puzzle? Why got the Bundesbank away with its practice of deviating time and again from announced targets? Why was it able to keep nevertheless the credibility that it truly cared about price stability?

The answer, I believe, is that the Bundesbank was the first central bank that provided the public with an intelligible numerical framework that facilitated the evaluation of its policy course from the outside (Neumann, 1999; Lohmann, 2003). Naturally, the population at large does not understand much about central banking and hardly knew anything about monetary targeting or its implications for inflation. But there is and was an elite audience consisting of bankers, economists and financial journalists. By offering public monetary targeting, the Bundesbank invited to be put under closer scrutiny as regards its aims, its model of how the economy works, its implementation procedures, its capability to do a good job. It enabled the elite to differentiate more closely between monetary policy actions that were defensible and those that were not.

Interesting analysis. What it says is it was not as much with setting monetary targets but setting a monetary policy framework which was transparent and considered credible by the market participants.

To be sure, the institution of targeting as such was not sufficient. The Bundesbank needed to provide detailed reasoning for the numbers it offered and for the final outcomes. And that the Bank did from the outset. Each year the Bank explained in detail what its evaluation was as regards last year’s target fulfilment, on which expectations the target range for the following year was based on and on which particular developments it would aim at the upper or the lower region of the range. During the course of the year the Bank reported and commented on ongoing developments and the degree of target fulfilment and mid-year the Bank checked officially whether the target was to be kept or revised.

Finally, it may be noted that the Bundesbank, if not all times, for most of the time was quite frank in its explanations. Remember that the Bank had no scruple to point out that the target overshot of 1992 was an all-time high. It fits that the Bank even admitted lack of knowledge on several occasions.

Great insights. It also conveys indirectly that it does not matter what mon pol strategy you choose (now the debate has narrowed to inflation targeters vs non-inflation targeters), what matters is whether you are transparent and credible in your operations.

Assorted Links

March 23, 2009

1. Krugman is baack. He says we need to be wary of quant easing by Fed. He also has a graph showing decline in industrial production in GD and now. He also does not like the new Obama Toxic Assets plan which has been leaked

2. Mankiw explains Ricardian equivalence

3. Urbanomics on India deflation issue

4. Econbrowser says Fed quant easing announcement has not been received well


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