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I examine how money and trend inflation shaped US macroeconomic dynamics during the Great Inflation. I develop a business cycle model with positive trend inflation where money is allowed (but not required) to play a role in determining the equilibrium values of inflation and output through non-separable utility, adjustment costs for holding real balances, and the monetary policy reaction function. The Taylor principle changes in this environment. Targeting money guarantees price determinacy even with trend inflation, but these results are sensitive to the inclusion of non-separability and portfolio adjustment costs. The framework is combined with Greenbook data that detect the role of money in the policy reaction function. The response to money was likely not sufficiently strong to complement the reaction to inflation and counteract the high trend inflation observed during the pre-Volcker period, which most likely led to price indeterminacy.
Although China’s monetary and financial system differs drastically from its Western counterpart, empirical studies covering this vast economy have often been simple reestimations or recalibrations of models originally designed to describe US or European monetary policy. In this paper, we aim to assess Chinese monetary policy and, in particular, monetary policy transmission through yield curves into the real economy. Our study takes into account the peculiarities of the Chinese economy: Namely, our model includes both China’s modern attempts at a market-based monetary policy as well as the “authority-based” one that is a relic of the original banking system. Besides, it considers the special nature of the Chinese treasury bond market, which is separated into two independent ones with very limited direct arbitrage opportunities between almost identical assets. Finally, it incorporates the role of real estate, which played an essential role in China during the last decade. Our results show that different monetary policy shocks cause asymmetric effects on macroeconomic and financial variables.
This chapter reconstructs the content of the three principles that play a key role in the constitution and the disciplining of public power in the European Union: ’sound money’, economic freedoms(s) and ’free’ competition. Such a trio is the fundamental parameter of the validity of all national norms, at the same time that the division of labour between supranational decision-making processes favours their reflection in European legislation, while constituting a major obstacle to efforts at approving regulations and directives promoting alternative socio-economic visions. The fundamental norms of the European Union also include norms and practices that shift decision-making powers from the supranational legislature to (some) private actors, (some) technocrats and (some) national governments. The result is the affirmation of private property as the sovereign value of European law, which requires that supranational public power becomes a powerful external constraint that once and at the same time constitutes, disciplines and fragments (national) public power.
This chapter argues that the combination of the European economic and monetary constitution with neo-liberal ideology amounts to a straitjacket that is impeding the necessary move towards a more sustainable economy. The chapter explores the limitations on Member State fiscal spending contained in the Treaty on the Functioning of the European Union, and contrasts those limitations with the very broad discretion granted to central banks to conduct monetary policy. Central banks’ ‘quantitative easing’ policies have, as they were intended to, boosted asset prices, skewing wealth distribution in favour of the already wealthy. They have also lowered the borrowing costs facing governments and large corporations, but it is not clear that they have been successful in terms of stimulating economic growth through higher investment and spending. Finally, the chapter looks at the EUs fiscal and monetary response to the COVID-19 pandemic. Does it mark a permanent change that may lead to a more sustainable economy, or, as the pandemic recedes, will the EU return to its constitutional and ideological straitjacket? We fear it will be the latter.
Macroeconomics for Emerging East Asia presents a distinctive approach to the study of macroeconomic theory and policy. The author develops a unique analytical framework that incorporates: (1) both internal and external balance as aspects of macroeconomic stability; (2) both the exchange rate and the interest rate as monetary policy instruments, (3) government debt sustainability as a concern of fiscal policy, and (4) global capital flows as a force to be reckoned with. The framework provides students with the foundational knowledge to analyze macroeconomic issues common to emerging economies. Concepts are illustrated using the latest empirical data and extensive case study analysis for thirteen economies of Northeast and Southeast Asia (Cambodia, China, Hong Kong, Indonesia, Korea, Laos, Myanmar, Malaysia, the Philippines, Singapore, Taiwan, Thailand, and Vietnam). The book's lucid exposition accommodates students of differing levels of preparation.
The Global Financial Crisis of 2008 was followed by an increased volatility in capital flows, posing considerable macro-financial risks, especially for emerging markets. Turkey addressed these macro-financial risks between 2010 and 2011. Principal decision makers at the Central Bank of the Republic of Turkey took policy actions by introducing policy mixes that trigger causal mechanisms informing the behaviour of bankers and their customers at the macro level to contain such risks. Utilising insights from causal mechanisms theory, critical realism, and realist evaluation, this article explores how the Central Bank implemented the policy mix. Our central argument is that at the macro level (i.e., structural and institutional contexts), causal mechanisms link actions with micro-level contexts (i.e., perceptions and reasoning of the target audience), whilst at the micro level, multiple causal mechanisms link policy outcomes with actor behaviour through non-linear feedback mechanisms. Our article contributes to the causal mechanisms literature by linking policy mixes and policy outcomes via causal mechanisms that informed agential actions and outcomes containing macro-financial risks.
The ECB started its QE called the PSPP in 2015 as a new monetary policy measure. By purchasing vast monthly amounts of main Member State government bonds, the ECB aimed to force investors towards riskier assets, which in turn, was to increase asset prices and support bank lending, and ultimately lead to growth and inflation. Constitutionally, QE was a new type of complication for the European Macroeconomic Constitution. The ECB became the largest creditor of Member States it was prohibited to finance. The constitutional assessment of the PSPP combines the analysis of the CJEU’s Weiss case that contains very limited constraints for the ECB, and more economic-constitutional and thus substantive analysis. One key question is whether the PSPP is monetary policy, which can be analysed through its objectives, its economic content and examples of other central banks that mostly support an affirmative conclusion. The euro area constitutional structure adds further complications that were also raised in the FCC’s Weiss judgment. The PSPP has arguably broader implications for other areas of economic policy, as it facilitates Member States public finances and increases wealth differences by increasing asset prices, as well as making the ECB deeply dependent on Member States public finances.
The ECB’s selective bond purchases raised constitutional controversies from the start. The SMP was criticised for overstepping the lines of EU monetary policy and basically financing Member States. The OMT was an effective lender of last resort for governments, although never operationalised. The purchases also gave rise to the first substantive CJEU judgment on monetary policy. The chapter combines economic and legal research to get to the heart of the problems. Specific questions relate to the role of government bonds in the transmission of monetary policy, and to the risks of contagion and currency redenomination as justifiable reasons to selective bond purchases. The broader constitutional assessment of the ECB selective purchases finds many critical areas for the EMU constitutional architecture. Some solutions such as the CJEU's excessive reliance on the objectives of measures for defining them as common monetary policy or Member States economic policy left room for criticism. The chapter argues that the principle of conferral risks becoming void if the independent ECB can effectively dictate its own mandate, calling for a more economic definition of monetary policy. In addition, the circumstances around the programmes raised questions concerning the independence of the ECB.
The chapter introduces and analyses the ECB as it was designed to become the central bank of the European Macroeconomic Constitution. It provides a view on how the ECB operates and how it aims to achieve price stability but also becomeaccountable. Three different but interlinked concepts are evaluated: monetary policy strategy, the monetary policy transmission mechanism, and the operational framework. Monetary policy strategy describes the ECB’s role in the economy and how it achieves its objectives. The monetary policy transmission mechanism is embedded in monetary policy strategy and seeks to explain how monetary policy measures are transmitted to the economy, and how monetary policy decisions affect the primary objective of price stability. The operational framework makes monetary policy decisions operational by proving the link from monetary policy decisions to money market interest rates and ultimately to the economy at large. These are discussed in turn after a brief description of the ECB’s organisation and decision-making bodies. A broad constitutional assessment of the ECB as it was designed finds that many elements raise some questions but generally the ECB confirmed the requirements of the European Macroeconomic Constitution, which is, in turn, a further confirmation of the constitutional reconstruction.
The book is about money, central banking and constitutions. It explains how the European Central Bank was established to ensure stability and prosperity for the euro area. The ECB was guided and controlled by a coherent European Macroeconomic Constitution. However, this model has failed during recurring crises, and the ECB has started to act as the euro area fire brigade. Consequently, it is pushing the boundaries of monetary policy, and with that challenging the accountability mechanisms and fundamentally also the democratic legitimacy of the EMU. The book sheds light on this complex economic-constitutional setting with a view on the future. The imbalance between various new operations and a single price stability objective is difficult to remedy. New objectives of financial stability, economic adjustment and environmental sustainability can cause fundamental ruptures between the ECB's formal role and its actions, and they also dangerously overburden monetary policy moving forward with substantial risks.
Unlike 1720 or 1793–97, the bubble of the 1820s was generated by the financial system itself: The new expansion of the banking system both domestically and internationally, the Bank of England’s monetary policies, the structure of corporate finance, and sovereign lending practices produced the bubble without any need for malfeasance or exogenous shocks. The bubble burst in late 1825, leading to the failure of more than 100 British banks and more than 1.000 businesses. At the height of the Panic of 1825, the decision about priorities and interests was taken not by a political sovereign or a regulatory legal institution, but by a private bank: Rothschilds bailed out the Bank of England, showing the power of financial markets over governance. For the first time, it was clear that financial markets could both cause and end financial crises regardless of political institutions. After 1825, financial crises became a predictable and intelligible part of life, caused by impersonal and abstract international markets, managed by central banks independent of political accountability, explained and analyzed by a self-authorized body of economic thought, with the costs borne by domestic populations and nobody in particular at fault.
Between 1797 and 1815, Britain and France each developed modern central banks, albeit in very different forms. The Bank of England’s powers expanded enormously after the suspension of gold convertibility in 1797, and it also developed a vast system of investigation and prosecution of forgery and counterfeiting, whose records form the evidentiary core of the chapter. The Bank used its powers to protect itself, but also to aid in broader English governance, helping to produce a modern money-using financial public. As with the aftermath of 1720, the Bank’s powers produced widespread political condemnation, especially accusations of illegitimate elite conspiracy. In France, the brief chaos of free banking was replaced by the centralized Bank of France, mostly under government control and with limited policy discretion. In both cases, impunity was institutionalized as a function of governance, delegated to a private bank with political obligations. These new institutions, exercising new forms of monetary policy, would reconstitute the operation of international financial system after 1815.
In the wake of the 2008–9 global financial crisis, the G20 devised a framework for a sustainable recovery based on international cooperation. An agreement was reached to ensure that inter alia macro-prudential and regulatory policies would support sustainable economies by preventing credit and asset price cycles from becoming forces for financial destabilization. The G20 recognized the importance of striking a balance between micro- and macro-prudential regulation to control risks, and to develop tools to monitor the build-up of systemic risk in the financial system. This chapter argues that the design of the supervisory structure is instrumental in striking the appropriate balance between these regulatory disciplines. Clear mandates and supervisory judgement are necessary to control this interdependent relationship. Regulatory underlap, gaps, and arbitrage can surface when the supervisory structure does not harmonize with legal infrastructure. To mitigate these regulatory flaws causing financial instability and producing unsustainable economies, supervisors must have sufficient capacity, expertise, awareness, and discretion. Attaining financial stability and a sustainable economy requires the supervisory structure or model, and the supervisor’s capacity and expertise to be harmonized with the legal infrastructure.
Banks can become illiquid when wholesale funding markets to not function for extended periods of time. Illiquidity quickly transforms into insolvency if liquid assets or cash flows cannot cover banks’ maturing liabilities. Since the 2008–9 global financial crisis, a new financial stability consensus has emerged whereby central banks began implementing unconventional liquidity tools. This chapter comparatively analyzes Hong Kong’s sectoral supervision with the integrated, functional, and Twin Peaks models when implementing unconventional liquidity tools. The macro- and micro-prudential characteristics of unconventional liquidity tools necessitate systemic supervision by central banks and banking supervisors. Effective systemic supervision of unconventional liquidity tools cannot be presumed merely by the presence of a systemic supervisory agency. Underlap can weaken systemic risk objectives and mandates when implementing unconventional liquidity tools because supervisory roles can become uncertain. In this context, Hong Kong’s composite systemic supervisor, the Financial Stability Committee, may not be able to properly coordinate member financial supervisors. Uncertainty can lead to tensions between Financial Stability Committee members, impeding systemic supervisory effectiveness. Tensions coupled with uncertainty can produce macro-prudential and systemic supervisory flaws when managing funding and market liquidity, heightening banking system instability.
Financial crises have a tendency to expose the financial system’s inability to absorb large systemic shocks, the critical role of liquidity channels, and financial institutions with fragile balance sheets. Pinpointing the causes of systemic risk challenges supervisors because the range of risks are virtually unlimited. This chapter argues that the definition of financial stability must be revisited to enhance the efficacy of financial supervision by drawing upon the lessons learnt from the 2008–9 global financial crisis. Defining systemic risk requires a real-time perspective of risk transmissions between the financial system components. Supervisors should appreciate financial agglomeration, the interconnectedness of the financial system, and behavioural economics when regulating systemic risk. Liquidity mismatches that destabilize financial institutions’ balance sheets and the capacity to raise funding can cause financial instability. The inability of the Hong Kong Monetary Authority to control monetary policy constrains its power to fully manage these liquidity risks. Mitigating financial instability caused by systemic liquidity risks requires an understanding of prudential regulation and the management of monetary policy to stabilize bank balance sheets. Financial architecture must be properly utilized by supervisors to restore the orderly and rational functioning of the financial system.
Choosing the optimum supervisory model to manage financial stability requires a consideration of country-specific preferences based on the level of market development and the configuration of the financial system. The choice of model, its structural design, and the regulatory mandates will influence a supervisor’s effectiveness for managing financial stability. This Chapter analyzes the sectoral models in Mainland China, the United States, and Hong Kong to showcase institutional design elements and variations across different financial systems. The chapter assesses the advantages and disadvantages of the unified central bank and banking supervisory design of the Hong Kong Monetary Authority. Understanding how monetary policies affect banking institutions can be critical for maintaining banking sector stability. A unified structure creates a supervisory synergy when calibrating the lender of last resort and unconventional liquidity tools because coordination tensions are eliminated. The Hong Kong Monetary Authority is compromised because of the Linked Exchange Rate System and the Interest Rate Adjustment Mechanism inhibits its ability to set and control interest rates which can destabilize the banking sector.
This article examines if professional forecasters form their expectations regarding the policy rate of the European Central Bank (ECB) consistent with the Taylor rule. In doing so, we assess micro-level data including individual forecasts for the ECB main refinancing operations rate as well as inflation and gross domestic product (GDP) growth for the Euro Area. Our results indicate that professionals indeed form their expectations in line with the Taylor rule. However, this connection has diminished over time, especially after the policy rate hit the zero lower bound. In addition, we also find a relationship between forecasters’ disagreement regarding the policy rate of the ECB and disagreement on future GDP growth, which disappears when controlling for monetary policy shocks proxied by changes in the policy rate in the quarter the forecasts are made.
We analyse the money-financed fiscal stimulus implemented in Venice during the famine and plague of 1629–31, which was equivalent to a ‘net-worth helicopter money’ strategy – a monetary expansion generating losses to the issuer. We argue that the strategy aimed at reconciling the need to subsidize inhabitants suffering from containment policies with the desire to prevent an increase in long-term government debt, but it generated much monetary instability and had to be quickly reversed. This episode highlights the redistributive implications of the design of macroeconomic policies and the role of political economy factors in determining such designs.
This paper examines the effectiveness of forward guidance shocks in the US. We estimate a New Keynesian model with imperfect central bank credibility and heterogeneous expectations using Bayesian methods and survey data from the Survey of Professional Forecasters (SPF). The results provide important takeaways: (1) The estimated credibility of the Fed’s forward guidance announcements is relatively high, but anticipation effects are attenuated. Accordingly, output and inflation do not respond as favorably as in the fully credible counterfactual. (2) The so-called “forward guidance puzzle” arises partly from the unrealistically large responses of macroeconomic variables to forward guidance under perfect credibility and homogeneous fully informed rational expectations, assumptions which are found to be jointly inconsistent with the observed US data. (3) Imperfect credibility provides a plausible explanation for the empirical evidence of forecasting error predictability based on forecasting disagreement found in the SPF data. Thus, we show that accounting for imperfect credibility and forecasting disagreements is important to understand the formation of expectations and the transmission mechanism of forward guidance.
We assess the effects of financial shocks on inflation, and to what extent financial shocks can account for the “missing disinflation” during the Great Recession. We apply a Bayesian vector autoregressive model to US data and identify financial shocks through a combination of narrative and short-run sign restrictions. Our main finding is that contractionary financial shocks temporarily increase inflation. This result withstands a large battery of robustness checks. Negative financial shocks help therefore to explain why inflation did not drop more sharply in the aftermath of the financial crisis. Our analysis suggests that higher borrowing costs after negative financial shocks can account for the modest decrease in inflation after the financial crisis. A policy implication is that financial shocks act as supply-type shocks, moving output and inflation in opposite directions, thereby worsening the trade-off for a central bank with a dual mandate.