I was reading this paper presented at RBA’s conference on 50 years of monetary policy. The paper is written by 2 RBA economists – Adam Cagliarni & Chrstopher Kent and RBA governor- Glenn Stevens. (You sometimes come across Presidents, Governors of Central Banks writing/co-writing research papers. It is amazing that they manage to contribute to research despite busy schedules)
This paper is another excellent review of how monetary policy/central banks have evolved over the past 50 years. The authors divide the 50 year period into 5 sub-periods:
- Rise of Monetarism (The 1960s and 1970s): By end of 1960s, Bretton Woods was under severe pressure. Under B-woods, as all countries had pegged their exchange rate to USD, the monetary policy function was given to Fed. But inflation rose in US and political pressures further bought B-woods down. Fiscal policy was seen as supreme though with rising inflation, discussions on mon pol and c-banks role started gaining. As inflation rose Friedman and monetarism became powerful. The role of expectations in inflation by Phelps, Lucas also became powerful stuff.
- Supply side measures (1970s onwards): inflation was supposed to be a demand phenomenon driven by increase in money supply till now. Because of oil shocks, inflation was shown to be affected by supply side as well.
- Rules vs Discretion debate (1970s and 1980s): Central Banks started searching for a proper framework for monetary policy. This was because of time consistency issues with central banks. The monetary targets also became difficult to pursue because of financial innovation and deregulation of financial markets. “We did not abandon M1, M1 abandoned us” became famous dictum. The search began for new monetary framework. Taylor rule became famous for its suggestion to run monetary policy like a rule. The countries were divided. US managed to lower inflation in Volcker’s time and did not follow any target but discretion. Euroarea favored rules for historic reasons of hyperinflation and success of Bundesbank in managing inflation following monetary targeting. They preferred a monetary union and then eventually led to ECB. Latin American and Asian economies had targeted exchange rates.
the question for small open economies was more complex as they did not have any anchors. This search led to development of inflation targeting in New Zealand followed by Canada, UK, Australia, Sweden, Norway etc. Very interesting indeed.
- Principles of Institutional design (the 90s): Central Bank independence, accountability and transparency came up
- Financial Stability is difficult to maintain (1980s, 1990s and 2000s): Financial stability kept being a problem all through out once B-woods collapsed. An era when financial globalization picked up. . The thought that it was an emerging market phenomenon was questioned when developed economies like Norway, Sweden, US – 2001 were impacted. This crisis has affected developed economies much more than developing ones. Cebtral banks realized the issues and started releasing financial stability reports but were not enough. The authors revisit the old debate of whether c-banks should intervene to prevent asset bubbles. Interestingly, they say we cannot ignore it anymore.
The challenges ahead: Two. First, how monetary policy works should address financial imbalances? Second, how would coordination between mon pol and fiscal pllicy fare out going forward…
A very good overview on developments in monetary policy. Interesting throughout. To put all in just 40 pages. A very comprehensive list of references as well.