Symmetrical Monetary Policy anyone?

Axel Weber, Chief of Bundesbank (Germany’s Central Bank) says:

The influence of monetary policy on the behaviour of financial market participants might be especially strong in the event that the central bank follows an asymmetric monetary policy that is lowering rates aggressively in the face of macroeconomic downturns but increasing rates only gradually when downside risks have vanished. Contrary to this approach, there is the idea of a symmetrical monetary policy, which would not consider the boom-bust phases in the financial markets as isolated events, but would try to look through the financial cycle and stabilise monetary policy.

Moreover, a symmetrical monetary policy would consider a higher key interest rate in the event of an increase in risk in the financial markets, even in the absence of inflationary risk or macroeconomic risks within the usual time horizon for monetary policy. This does not mean that the central bank would abandon its primary goal of price stability in favour of other intentions. The central bank would rather take a longerterm perspective and include the future consequences of unfavourable trends in the financial markets in its analysis.

This is interesting as it is coming from a Central Banker as they have resisted this all along. He is quite powerful as well and it will be interesting to see other central bankers also saying something similar. If there was no ECB, Bundesbank would have been the next powerful after Fed. Moreover, ECB has been largely on style of Bundesbank.

He also adds, ECB has already showed the way here:

In this respect, the Eurosystem has a very valuable analytical tool for the medium to longrun perspective: monetary analysis. This tool forces us to extend the analytical horizon beyond the usual time span of two years and to include the low frequency movements of monetary and credit aggregates in monetary analysis and the decision-making process. Hence, the Eurosystem already has an important stabilising element that enables us to counteract procyclical trends in our monetary decision-making. In future, this aspect of monetary policy will need to gain in importance.

I came across another interesting idea from Arvind Subramanian and John Williamson of Peterson Institute for International Economics on this topic.

The Greenspan “put”—the idea of Alan Greenspan, former US Federal Reserve chairman, that monetary and regulatory policy cannot prick asset price bubbles but should deal with the consequences when the bubble has burst—now looks dangerously quaint. Such “asymmetric” policy responses are out. But if they are to be replaced by more symmetric, countercyclical policies, then explicit or implicit target or guidance zones for the prices of all main assets—shares, housing, exchange rates, and perhaps even oil—are unavoidable.

Mr. Greenspan wanted to address the hangover. It is surely better to avoid drunkenness.

This takes Weber’s idea (and others) to another extreme. These two instead say Central banks should have target zones for individual assets. Interestingly, yhey quote a former Bundesbank president:

Otmar Emminger, former Bundesbank president, used to say that, while he could not identify an equilibrium exchange rate, he could certainly tell a disequilibrium rate. We are asking no more than that the authorities should think in advance about what disequilibrium rates for asset prices look like and seek to keep rates from straying into such realms.

The width of the zone should certainly vary depending on the asset and the associated uncertainty in determining equilibrium asset price levels. Note that history provides guides for assets other than exchange rates: When house-price/income ratios, or price/earnings ratios depart far from historical levels, they revert. One might accor­dingly think of a zone for house prices of, perhaps, plus or minus 30 percent; and for equities of, say, plus or minus 40 percent; and, more controversially, for oil of, say, $40–80 per barrel. Some might balk at trying to set floors for asset prices. But proposals in the current crisis, from government purchases of equity to lowering mortgage interest rates in order to prevent housing foreclosures, amount in effect to setting floors.

🙂 They also say intervention would dioffer on the nature of the bubble

The corrective action would depend on the nature of the bubble. It could be either national or international. For example, if the departure relates to the exchange rate, coordinated intervention might be warranted. In the case of oil, cooperation between the main oil exporters and importers might be necessary. Or, if sharp increases in asset prices were concentrated in some sectors, directed prudential policies (such as greater provisioning, higher margins, or tighter capital adequacy standards) or higher taxes would be called for. If, however, increases in asset prices were more broadly based and related to credit expansion generally, tightening monetary policies would be a more appropriate option.

The guidance zones should be made public. They would provide a signal that departures from these zones would elicit policy action. These actions should become stronger the greater the departures, in strong contrast to past behavior in the exchange market, where a successful attack on a publicly announced margin was rewarded by a withdrawal of the authorities.

Loads of work is still pending for the Central Bankers.


2 Responses to “Symmetrical Monetary Policy anyone?”

  1. Interest Rates » Symmetrical Monetary Policy anyone? « Mostly Economics Says:

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  2. US economy in worst condition since World War 2 - US Finance News | US Finance Market Updates Says:

    […] Symmetrical Monetary Policy anyone? « Mostly Economics […]

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