Archive for December 29th, 2008

What is the best practice monetary policy?

December 29, 2008

I didn’t know something like this existed. Anyways, Lars Svensson in this paper says it started with Norway Central Bank and is now followed by Sweden and NZ as well.

What is it but?

The impact of monetary policy on inflation and output depends on the private-sector decisions about prices and output that it induces. These decisions depend on the expectations about future inflation, output, and interest rates that monetary policy induces.

The current instrument rate matters hardly at all; what matters for private-sector decisions are the private sector’s expectations about future interest rates. Therefore, the implementation of best-practice monetary policy consists of announcing and motivating the bank’s forecasts of inflation, the output gap, and, importantly, the instrument rate.This is the most effective way of managing private-sector expectations.

(emphasis is mine)

In nut shell- central banks usually publish their forecasts of inflation and growth. What makes it best practice is forecasts of their own interest rates as well.

Four alternatives have been discussed for the instrument-rate path: (1) A constant instrument rate, (2) market expectations of future interest rates, (3) an instrument rate following an instrument rule, such as the Taylor rule, (4) an optimal instrument-rate path, that is, the path the central bank believes best achieves the bank’s objectives, which will also be the central bank’s own best forecast of future instrument rates.

I am convinced that best-practice monetary policy involves alternative (4), the optimal instrument rate forecast, that is, the central bank’s best forecast of its own future policy. By definition, this is the path the central bank deems to be optimal. Furthermore, since it is the best forecast of future interest rates, it provides the best information for private-sector decisions. Therefore, this is the most effective implementation of monetary policy, that is, the most effective way to manage private sector expectations. Finally, it provides the most accountability for the central bank. Since the resulting inflation and output-gap forecast rely on the central bank’s best instrument-rate forecasts, they are the central bank’s best inflation and output-gap forecast. Therefore, these  forecasts are the most relevant ones to compare with other forecasters’ forecasts and with the actual outcomes.

A nice short note on Inflation targeting

December 29, 2008

Jane Sneddon Little (Boston Fed Economist) and Teresa Romano  have written a nice review on inflation targeting. It is a useful primer and a literature survey on the subject. It reviews the experience in the inflation targeting countries and also has nice inputs on how certain countries applied the inflation targeting .

Assorted Links

December 29, 2008

1. Krugman points positive yield curve doesn’t imply US is out of woods.

2. Krugman points to Fed Credit Card 🙂 Krugman points mortgage rates are too high Krugman points to his hangover theory 

3. Mankiw points to a story of a young economics student which is very much a universal problem.

4. FinProf points SEC was made aware of Madoff. What is going on?

5. DB points to accuracy of its indicators. It also has an excellent post on whether democracy causes growth or other way round

6. Blataman has some useful travel tips

7. TTR on Corporate Governnance issues. In another post TTR says we need few more cities to take burden off Mumbai . I completely agree and this has been said many times by many people. When will this actually happen?

8. Cowen asks was bailing out  LTCM a good idea?

9. IDB points to some innovation in creating awareness on AIDS

10. ICB has an interesting summaryon what happened in 2008 in Indian securities laws

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