The system of Eurozone central banks has recently taken a large step away from traditional inflation targeting towards more active policies aimed at also guaranteeing financial stability. One can doubt the effectiveness of the new policies which, after all, are new. And unemployment is only mentioned in passing though the new policies implicitly admit that the post 2008 rise in Eurozone unemployment was not caused by rigid labour markets. But by a crisis. Despite this the new policies are a very welcome (though severly overdue) step ahead: they admit that too much credit is a dangerous thing, especially when it leads to asset price increases.Real-World Economics Review Blog
Central Banking in the Eurozone: moving away from ‘inflation targeting’
Merijn Knibbe
4 comments:
Meanwhile back in China, The Chinese politicians and economists are working on real problems...
What policy choices does a central bank have for "controlling inflation" ?
I'm not being silly, I would like to know.
Thanks
Central bankers know that in an endogenous system, the private sector is able to expand the money stock by credit, which is mostly extended for investment, which is money that gets spent rather quickly. So the strategy is to increase the cost of borrowing by increasing interest rates.
The only tool that cb has to control price is the policy rate. Changing the policy rate affects yields along the curve, so it affects not only short term rates but also long term rates.
If inflation is expected, the cb raises the policy rate, knowing that banks figure spreads off the policy rate, so this affects the prime rate for short term borrowing by the most creditworthy, i.e., large firms. This affects short term financing like working capital.
Long terms rates are projections of the short term rate, the benchmark long-term rate is the 10yr, and its yield is figured as a geometric average of the expected future short rates, plus term and credit premia. This affects yield of corporate bonds, hence the rate at which new bonds are issued, and also commercial and residential mortgage rates.
However, rate increases also increase the income of lenders and the amount received by savers from government securities, so that tends to counter the increased cost of borrowing if the interest payments are also spent.
Thanks Tom:
I appreciate the response.
Post a Comment