WHAT SHOULD CENTRAL Frederic

Mishikin -
BANKS DO? 2000
 WHAT IS THE CENTRAL BANK

 Government org responsible for monetary policy

 The Fed, Federal Reserve, Federal Reserve Bank System
 Uses instruments to control inflation or recession
 Sells and redeems government securities
 Regulates money supply
 Issues currency
 Controls inter-bank interest rate
 Chaired by Ben Bernanke, previously Alan Greenspan
 SOME TERMS

 Price stability – Prices have minimal inflation or deflation

 Output Stability – Slow and steady GDP growth, minimal fluctuation
 Monetize the Debt – Government issues debt to finance spending.
Spending is then purchased by central bank which increases money
supply. Leads to excessive inflation.
 MISHKINS PRINCIPLES

 Price stability provides substantial benefits

 Fiscal policy should be aligned with monetary policy
 Time inconsistency is a serious problem to be avoided
 Monetary policy should be forward looking
 Accountability is a basic principle of democracy
 Monetary policy should be concerned about output as well as price
fluctuations
 The most serious economic downturns are associated with financial
instability
PRICE STABILITY PROVIDES SUBSTANTIAL BENEFITS

 Central banks should target price stability

 US Government has only recently stated this is a goal
 FISCAL POLICY SHOULD BE ALIGNED WITH
MONETARY POLICY

 Fiscal policy should follow goals of the central bank

 Central bank would be first mover – government follows

 Realistic?
TIME INCONSISTENCY IS A SERIOUS PROBLEM
TO BE AVOIDED

 The policy maker or the policy changes frequently – this

should be avoided
 Fiscal policy tends to be driven by the short run
 Monetary policy should be leader, not fiscal
 Employment objectives should not compromise long term
inflation targets
 MONETARY POLICY SHOULD BE FORWARD
LOOKING

 Monetary policy has a long lag factor

 Needs to act preemptively
 ACCOUNTABILITY IS A BASIC PRINCIPLE OF
DEMOCRACY

 Central Bank should be transparent

 Responsible to electorate
MONETARY POLICY SHOULD BE CONCERNED ABOUT
OUTPUT AS WELL AS PRICE FLUCTUATIONS

 Price stability is a means to a healthy economy

 Long run strategy should be towards minimizing output
fluctuations and price stability
 THE MOST SERIOUS ECONOMIC DOWNTURNS ARE
ASSOCIATED WITH FINANCIAL INSTABILITY

 Great Depression, Housing Bubble, Savings and Loan

 Financial instability can defeat all monetary efforts
 Central bank must work to avoid instability
 IMPLICATIONS FOR CENTRAL BANK

 Price stability should be the overriding, long- run goal of

monetary policy
 An explicit nominal anchor should be adopted;
 A central bank should be goal dependent
 A central bank should be instrument independent
 A central bank should be accountable
 A central bank should stress transparency and
communication
 A central bank should also have the goal of financial
stability.
 QUESTIONS

 Can fiscal policy take a back seat to monetary policy in our

country?

 Is inflation the right nominal target? What about output

growth or employment rate?