XML

Seoul Journal of Economics - Vol. 24 , No. 4
[Paper List] [Go to Volume List]

[ Article ]
Seoul Journal of Economics - Vol. 24, No. 4, pp. 427-470
Abbreviation: SJE
ISSN: 1225-0279 (Print)
Print publication date 30 Nov 2011
Received 30 Sep 2010 Revised 21 Oct 2010 Accepted 22 Oct 2010

Implementing Monetary Policy
Carl E. Walsh
Professor, Department of Economics, UC Santa Cruz, 1156 High St., Santa Cruz, CA 95064, USA, Tel: +1-831-459-4082, Fax: +1-831-459-5077 (walshc@ucsc.edu)

JEL Classification: E52, E58

Abstract

During the past three years, central banks have faced challenges that few foresaw during the period known as the Great Moderation. During the crisis, central banks have responded with traditional interest rate tools, been forced to deal with the zero lower bound on nominal interest rates, and expanded the scope of their lender of last resort function. In addition, quantitative easing and credit easing policies have entered the toolkit of central banks. After briefly discussing the instruments of monetary policy and reviewing the performance of inflation targeting, I consider three suggested modifications to this policy framework. These are raising the average target for inflation, incorporating additional objectives, and switching to price level targeting.

Keywords: Monetary policy, Inflation targeting
Acknowledgments

This paper is based on one prepared for the 2010 Bank of Korea International Conference, May 31-June 1, 2010 which, in turn, draws from Walsh (2009b). I would like to thank Mark Carney, Jouko.Vilmunen, and Tony Yates for comments on earlier versions of some of this material.

References
1. Adams, K., and Billi, R. M. “Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates.” Journal of Money, Credit, and Banking 39 (No. 7 2006): 1877-905.
2. Adams, K., and Billi, R. M. “Discretionary Monetary Policy and the Zero Lower Bound on Nominal Interest Rates.” Journal of Monetary Economics 54 (No. 3 2007): 728-52.
3. Akerlof, G. A., Dickens, W. R., and Perry, G. L. “The Macroeconomics of Low Inflation.” Brookings Papers on Economic Activity 27 (No. 1 1996): 1-76.
4. Alvarez, F., Atkeson, A., and Kehoe, P. J. “Money, Interest Rates, and Exchange Rates with Endogenously Segmented Markets.” Journal of Political Economy 110 (No. 1 2002): 73-112.
5. Andrés, J., López-Salido, J. D., and Nelson, E. “Tobin's Imperfect Asset Substitution in Optimizing General Equilibrium.” Journal of Money, Credit, and Banking 36 (No. 4 2004): 665-90.
6. Auerbach, A. J., and Obstfeld, M. “The Case for Open-Market Purchases in a Liquidity Trap.” American Economic Review 95 (No. 1 2005): 110-37.
7. Bailey, M. J. “The Welfare Costs of Inflationary Finance.” Journal of Political Economy 64 (No. 2 1956): 93-110.
8. Battini, N., and Yates, A. “Hybrid Inflation and Price-Level Targeting.” Journal of Money, Credit, and Banking 35 (No. 3 2003): 283-300.
9. Benigno, P., and Ricci, L. A. The Inflation-Output Trade-Off with Downward Wage Rigidities. NBER Working Paper 15762, Feb., 2010.
10. Bernanke, B. S. Asset-Price ‘Bubbles’ and Monetary Policy. Remarks before the New York Chapter of the National Association for Business Economists, New York, Oct. 15, 2002.
11. Bernanke, B. S., and Gertler, M. “Agency Costs, Net Worth, and Business Fluctuations.” American Economic Review 79 (No. 1 1989): 14-31.
12. Bernanke, B. S., and Gertler, M. “How Should Central Bankers Respond to Asset Prices?” American Economic Review Papers and Proceedings 91 (No. 2 2001): 253-7.
13. Bernanke, B. S., Gertler, M., and Gilchrist, S. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In J. B. Taylor and M. Woodford (eds.), Handbook of Macroeconomics. Vol. 1C, Amsterdam: Elsevier North-Holland, pp. 1341-93, 1999.
14. Bernanke, B. S., Reinhart, V. R., and Sack, B. P. “Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment.” Brookings Papers on Economic Activity 35 (No. 2 2004): 1-100.
15. Billi, R. M. Price-Level Targeting and Risk Management in a Low-Inflation Economy. Federal Reserve Bank of Kansas City, Nov., 2008.
16. Blanchard, O., delil'Aricca, G., and Mauro, P. “Rethinking Macroeconomic Policy.” Journal of Money, Credit, and Banking 42 (No. S1 2010): 199-215.
17. Borio, C., and White, W. R. Whither Monetary and Financial Stability? The Implications of Evolving Policy Regimes. Monetary Policy and Uncertainty: Adapting to a Changing Economy. A Symposium Sponsored by the Federal Reserve Bank of Kansas City, pp. 131-211, 2003.
18. Carlson, J., Haubrich, J. G., Cherny, K., and Wakefield, S. “Credit Easing: A Policy for a Time of Financial Crisis.” Economic Trends. Federal Reserve Bank of Cleveland, Feb. 11, 2009.
19. Cateau, G., Kryvstov, O., Shukayev, M., and Ueberfeldt, A. Adopting Price-Level Targeting under Imperfect Credibility in ToTEM. Bank of Canada Working Paper 2009-17, 2008.
20. Cecchetti, S. G., Genberg, H., Lipsky, J., and Wadhwani, S. Asset Prices and Central Bank Policy. Geneva Reports on the World Economy, No. 2, 2000.
21. Cecchetti, S. G., Genberg, H., and Wadhwani, S. Asset Prices in a Flexible Inflation Targeting Framework. NBER Working Paper No. W8970, 2002.
22. Chari, V. V., Kehoe, P. J., and McGrattan, E. R. “New Keynesian Models: Not Yet Useful for Policy Analysis.” American Economic Journal Macroeconomics 1 (No. 1 2009): 242-66.
23. Christiano, L., Motto, R., and Rostagno, M. Financial Factors in Business Cycles. Manuscript, Nov., 2007.
24. Clouse, J., Henderson, D., Orphanides, A., Small, D. H., and Tinsley, P. A. “Monetary Policy When the Nominal Short-Term Interest Rate is Zero.” Topics in Macroeconomics 3 (No. 1 2003): Article 12.
25. Cúrdia, V., and Woodford, M. Credit Frictions and Optimal Monetary Policy. Discussion Papers 0809-02, Columbia University, 2008.
26. Cúrdia, V., and Woodford, M. “Credit Spreads and Monetary Policy.” Journal of Money, Credit, and Banking 42 (No. S1 2010): 2-35.
27. De Fiore, F., and Tristani, O. “Optimal Monetary Policy in a Model of the Credit Channel.” European Central Bank Working Paper Series No. 1043, April, 2009.
28. Demirel, U. D. “Optimal Monetary Policy in a Financially Fragile Economy.” The B.E. Journal of Macroeconomics: Contributions 9 (No. 1 2009): Article 15.
29. Dib, A., Mendicino, C., and Zhang, Y. Price-Level Targeting in a Small Open Economy with Financial Frictions: Welfare Analysis. Bank of Canada Working Paper 2008-40, 2008.
30. Eggertsson, G. B., and Woodford, M. “The Zero Bound on Interest Rates and Optimal Monetary Policy.” Brookings Papers on Economic Activity 34 (No. 1 2003): 139-211.
31. Erceg, C. J., Henderson, D., and Levin, A. T. “Optimal Monetary Policy with Staggered Wage and Price Contracts.” Journal of Monetary Economics 46 (No. 2, 2000): 281-313.
32. Faia, E., and Monacelli, T. “Optimal Interest Rate Rules, Asset Prices, and Credit Frictions.” Journal of Economic Dynamics and Control 31 (No. 10 2007): 3228-54.
33. Friedman, B. M. “Why the Federal Reserve Should Not Adopt Inflation Targeting.” International Finance 7 (No. 1 2004): 129-36.
34. Friedman, M. “The Optimum Quantity of Money.” The Optimum Quantity of Money and Other Essays. Chicago: Aldine Publishing Co., pp. 1-50, 1969.
35. Gagnon, J., Raskin, M., Remarche, J., and Sack, B. Large-Scale Asset Purchases by the Federal Reserve: Did They Work? Federal Reserve Board, Staff Report No. 441, March, 2010.
36. Galí, J. Monetary Policy and Unemployment. NBER Working Paper 15871, forthcoming, Handbook of Monetary Economics, 2010.
37. Gertler, M. Commentary: Whither Monetary and Financial Stability? The Implications of Evolving Policy Regimes. Monetary Policy and Uncertainty: Adapting to a Changing Economy. A Symposium Sponsored by the Federal Reserve Bank of Kansas City, pp. 213-23, 2003.
38. Gertler, M., and Karadi, P. “A Model of Unconventional Monetary Policy.” Journal of Monetary Economics 58 (No. 1 2011): 11-34.
39. Gertler, M., and Kiyotaki, N. “Financial Intermediation and Credit Policy in Business Cycle Analysis.” In B. M. Friedman and M. Woodford (eds.), Handbook of Monetary Economics. Vol. 3, Elsevier B.V., pp. 547-99, 2011.
40. Goodfriend, M. “Overcoming the Zero Bound on Interest Rate Policy.” Journal of Money, Credit, and Banking 32 (No. 4 2000): 1007-35.
41. Goodfriend, M. “How the World Achieved Consensus on Monetary Policy.” Journal of Economic Perspectives 21 (No. 4 2007): 47-68.
42. Haefke, Christian, Sonntag, Marcus, and van Rens, Thijs. Wage Rigidity and Job Creation. IZA Discussion Paper 3714, 2007.
43. Hutchison, M. M., Ito, T., and Westermann, F. “The Great Japanese Stagnation: Lessons for Industrial Countries.” In M. M. Hutchison and F. Westermann (eds.), Japan's Great Stagnation: Financial and Monetary Policy Lessons for Advanced Industrial Countries. Cambridge, MA: The MIT Press, pp. 1-32, 2006.
44. Ireland, P. N. “On the Welfare Cost of Inflation and the Recent Behavior of Money Demand.” American Economics Review 99 (No. 3 2009): 1040-52.
45. Ito, T. Inflation Targeting and Japan: Why Has the Bank of Japan Not Adopted Inflation Targeting? NBER Working Paper 10818, 2004.
46. Kahn, George A. Beyond Inflation Targeting: Should Central Banks Target the Price Level? Federal Reserve Bank of Kansas City, Economic Review, 2009.
47. Kohn, D. L. Monetary Policy and Asset Prices Revisited. Speech to the Cato Institute's 26th Annual Monetary Policy Conference, Washington, D.C., Nov. 19, 2008.
48. Krugman, P. R. “It's Baaack: Japan's Slump and the Return of the Liquidity Trap.” Brookings Papers on Economic Activity 29 (No. 2 1998): 137-205.
49. Kryvstov, O., Shukayev, M., and Ueberfeldt, A. Adopting Price-Level Targeting under Imperfect Credibility. Bank of Canada Working Paper 2008-37, 2008.
50. Kudlyak, M. The Cyclicality of the User Cost of Labor with Search and Matching. FRB of Richmond WP No. 09-12, 2009.
51. Levin, A., López-Salido, D., Nelson, E., and Yun, T. “Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound.” International Journal of Central Banking, forthcoming, 2009.
52. McCallum, B. T. “Issues in the Design of Monetary Policy Rules.” In J. B. Taylor and M. Woodford (eds.), Handbook of Macroeconomics. Amsterdam: Elseview Science B. V., vol. 1C, pp. 1483-530, 1999.
53. McCallum, B. T. “Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates.” Journal of Money, Credit, and Banking 32 (No. 4 2000): 870-904.
54. Meltzer, A. H. “Monetary Credit and (Other) Transmission Processes: A Monetarist Perspective.” Journal of Economic Perspectives 9 (No. 4 1995): 49-72.
55. Mishkin, F. S. “Is Monetary Policy Effective during Financial Crises?” American Economic Review 99 (No. 2 2009): 573-7.
56. Modigliani, Franco, and Sutch, Richard. “Debt Management and the Term Structure of Interest Rates: An Empirical Analysis of Recent Experience.” Journal of Political Economy 75 (No. 3 1967): 569-89.
57. Nakov, A. “Optimal and Simple Monetary Policy Rules with Zero Floor on the Nominal Interest Rate.” International Journal of Central Banking 4 (No. 2 2008): 73-128.
58. Pissarides, Christopher A. “The Unemployment Volatility Puzzle: Is Wage Stickiness the Answer?” Econometrica 77 (No. 5 2009): 1339-69.
59. Ravenna, F., and Walsh, C. E. “Welfare-Based Optimal Monetary Policy with Unemployment and Sticky Prices: A Linear-quadratic Framework.” American Economic Journals: Macroeconomics 3 (No. 2 2011): 130-62.
60. Reifschneider, D., and Williams, J. “Three Lessons for Monetary Policy in a Low Inflation Era.” Journal of Money, Credit, and Banking 32 (No. 4 2000): 936-66.
61. Reinhart, C. M., and Rogoff, K. S. This Time is Different: Eight Centuries of Financial Folly. Princeton, N.J.: Princeton University Press, 2009.
62. Roger, S. “Inflation Targeting Turns 20.” Finance and Development 47 (No. 1 2010): 46-9.
63. Rose, A. K. “A Stable International Monetary System Emerges: Bretton Woods, Reversed.” Journal of International Money and Finance 26 (No. 5 2007): 663-81.
64. Rotemberg, J. J., and Woodford, M. An Optimizing-Based Econometric Model for the Evaluation of Monetary Policy. NBER Macroeconomic Annual, Cambridge, MA: MIT Press, pp. 297-346, 1997.
65. Sellon, G. H. Jr. Monetary Policy and the Zero Bound: Policy Options When Short-Term Rates Reach Zero. Federal Reserve Bank of Kansas City, Economic Review, Fourth Quarter, pp. 5-43, 2003.
66. Spiegel, M. M. Did Quantitative Easing by the Bank of Japan ‘Work’? Economic Letter, Federal Reserve Bank of San Francisco, 2006-28, Oct. 20, 2006.
67. Stock, J. H., and Watson, M. W. “Forecasting Output and Inflation: The Role of Asset Prices.” Journal of Economic Literature 41 (No. 3 2003): 788-829.
68. Summers, L. “Panel Discussion: How Should Long-Term Monetary Policy Be Determined?” Journal of Money, Credit, and Banking 23 (No. 3 1991): 625-31.
69. Svensson, L. E. O. “Price Level Targeting vs. Inflation Targeting.” Journal of Money, Credit, and Banking 31 (No. 3 1999): 277-95.
70. Svensson, L. E. O. “The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap.” Monetary and Economic Studies 19 (No. S-1, 2001): 277-312.
71. Svensson, L. E. O. “Monetary Policy and Real Stabilization.” Federal Reserve Bank of Kansas City Jackson Hole Symposium, Rethinking Stabilization Policy (2002): 261-312.
72. Svensson, L. E. O. “Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others.” Journal of Economic Perspectives 17 (No. 4 2003): 145-66.
73. Svensson, L. E. O., and Woodford, M. “Implementing Optimal Policy through Inflation-Forecast Targeting.” In Bernanke, B. S. and M. Woodford, (eds.), The Inflation-Targeting Debate. Chicago: University of Chicago Press, pp. 19-83, 2005.
74. Thomas, C. “Search and Matching Frictions and Optimal Monetary Policy.” Journal of Monetary Economics 55 (No. 5 2008): 936-56.
75. Tobin, J. “A General Equilibrium Approach to Monetary Theory.” Journal of Money, Credit, and Banking 1 (No. 1 1969): 15-29.
76. Vestin, D. “Price-Level Targeting versus Inflation Targeting.” Journal of Monetary Economics 53 (No. 7 2006): 1361-76.
77. Walsh, C. E. “Speed Limit Policies: The Output Gap and Optimal Monetary Policy.” American Economic Review 93 (No. 1 2003): 265-78.
78. Walsh, C. E. “Labor Market Search, Sticky Prices, and Interest Rate Policies.” Review of Economic Dynamics 8 (No. 4, 2005): 829-49.
79. Walsh, C. E. “Inflation Targeting: What Have We Learned.” the John Kuszczak Memorial Lecture, the Bank of Canada, International Finance 12 (No. 2 2009a): 195-233.
80. Walsh, C. E. Using Monetary Policy to Stabilize Economic Activity. Federal Reserve Bank of Kansas City, Financial Stability and Macroeconomic Policy, 2009 Jackson Hole Symposium, forthcoming, 2009b.
81. Walsh, C. E. Monetary Theory and Policy. 3rd ed., Cambridge, MA: The MIT Press, 2010.
82. Williams, John C. “Heeding Daedalus: Optimal Inflation and the Zero Lower Bound.” Brookings Papers on Economic Activity 40 (No. 2 2009): 1-49.
83. Woodford, M. Money, Interest, and Prices. Princeton: Princeton University Press, 2003.
 

Editorial Office, Seoul Journal of Economics, Institute of Economic Research, Seoul National University 599 Gwanangno, Gwanak-gu, Seoul 151-746, Korea
Tel: +82-2-880-5434 | Fax: +82-2-888-4454 | E-mail: sje@plaza.snu.ac.kr
Copyright (c) 2020 SJE. All rights reserved.