Is US Monetary Policy Made in China?

China s Monetary Policy Surprise

China s Monetary Policy Choice

Why is Monetary Policy Underrated?

Shinzo Abe s Monetary Policy Delusions

1. Strongly anti inflationary monetary policy.

What Monetary Policy Does China Need?

It remains to be seen whether it can effectively restore some monetary policy influence. However, an important issue is rarely mentioned in small, open economies a description that applies to almost every country except the US the main channel of monetary policy is the exchange rate.

Of course, a country s monetary policy does affect exchange rates in the short term. But it does so only in relation to monetary policy in other relevant countries.

This simply reflects the reality of monetary policy interdependence if the US Federal Reserve s policy of so called quantitative easing weakens the dollar, others have to respond to prevent undue appreciation of their currencies. Someday, we might achieve closer global monetary policy coordination for now, however, it made sense for Japan to respond, albeit belatedly, to developments elsewhere.

In the early 1930 s, monetary policy incoherence paralyzed US policy, with the Federal Reserve Bank of New York locked in insurmountable conflict with the Chicago Fed over monetary easing (at that time through open market securities purchases). Today s chronic policy disputes between Germany and France are producing a level of uncertainty that is potentially even more destructive.

The market had strongly expected adjustments to UK monetary policy.

Yet widespread concerns persist. The International Monetary Fund for example, has argued that any rate hike by the Fed would need an effective monetary policy communication strategy a polite way of saying that any monetary tightening in the US and other advanced economies would be premature.

Monetary policy would have been more effective in the US had more attention been devoted to credit blockages for example, many homeowners refinancing problems, even at lower interest rates, or small and medium size enterprises lack of access to financing. Japan s monetary policy, one hopes, will focus on such critical issues.

Monetary policy would have been more effective in the US had more attention been devoted to credit blockages 160 for example, many homeowners refinancing problems, even at lower interest rates, or small and medium size enterprises lack of access to financing. Japan s monetary policy, one hopes, will focus on such critical issues.

A Cautionary History of US Monetary Tightening

Those of us who fear that the Fed s approach has greatly deepened the US economy s malaise and is turning America s cyclical unemployment into permanent long term structural non employment have lost the domestic monetary policy argument. But there is another policy argument that needs to be joined.

That brings us to monetary policy, the importance of which as a determinant of commodity prices is often forgotten. Monetary tightening is widely anticipated in the US, with the Federal Reserve having ended quantitative easing in October and likely to raise short term interest rates sometime in the coming year.

The US could benefit from such policies, as capital account regulation would force investors to find opportunities at home, while a true global reserve currency would free the US from concerns and harsh rebukes about the implications of its monetary policy on the global economy. At the same time, emerging markets would gain the full benefits of expansionary monetary policy in the US, to the extent that it boosts demand for their exports.

The Great Depression was intensified by poor monetary policy, tax hikes, and protectionist trade policies. Likewise, loose US monetary policy in the middle of the last decade helped to set the stage for the Great Recession by contributing significantly to an explosion of leverage and fueling the housing bubble that burst in 2007 2008.

In any case, the success of monetary policy is difficult to deny. As the deflation gap narrows, however, the overall impact of monetary policy will weaken, as it increasingly influences prices more than output.

Still to be argued out within the guild of economists , Samuelson wrote in 1969, is the proper quantitative potency of monetary versus fiscal policy. This question eventually was resolved in favor of monetary policy.

Moreover, unlike major developed economies, most of which have used up all of their conventional monetary policy ammunition by reducing their policy interest rates to zero, China has plenty of monetary stimulus on reserve to address cyclical disruptions. In these circumstances, it makes sense for China to lean more on monetary policy than on fiscal expansion.

Monetary policy needs to look beyond its core focus on low and stable inflation and pay much greater attention to financial stability. The debate now is how, exactly, to factor this imperative into monetary policy, and how to coordinate the work of monetary and regulatory authorities.

LONDON Now that the pace of the US Federal Reserve s tapering of its asset purchase program has been debated to death, attention will increasingly turn to prospects for interest rate increases. But another question looms How will central banks achieve a final exit from unconventional monetary policy and return balance sheets swollen by unconventional monetary policy to normal levels?

This episode showed that the renminbi is under significant depreciation pressure, which is likely to intensify as the PBOC, amid weak GDP growth, loosens monetary policy (particularly as the US Federal Reserve is gradually tightening its monetary policy). Add to that efforts to liberalize the capital account and internationalize the renminbi, and some exchange rate volatility can be expected.

The US Federal Reserve exemplifies this policy dilemma. After the Federal Open Market Committee decided in September to defer yet again the start of its long awaited normalization of monetary policy, its inflation doves are openly campaigning for another delay.

This is not the type of volatile monetary policy that Europe wants or needs.

Domestic monetary policy has become the first and last line of defense against growth slowdowns and financial panics, enabling policymakers to avoid pursuing other important, but far more difficult measures. Using monetary policy to compensate for deficiencies in other policy areas constitutes an institutional breakdown monetary policymakers are not necessarily getting it wrong, but they are constrained by the configuration of other policies.

If monetary policy is used to try to push unemployment below some pre determined level, inflation will accelerate without limit and destroy jobs. A monetary policy aiming for sub NAIRU unemployment must therefore be avoided at all costs.

Europe s monetary unification of the 1990 s was supposed to be accompanied by fiscal convergence and harmonization. When budgets move in different directions, pressures shift to regional policy (to redistribute income) and to monetary policy (to boost growth).

The current approach, centered on unconventional monetary policy, is not the answer. Though monetary policy provided a powerful antidote to frozen credit markets in the depth of the global financial crisis, it has failed to spark classic cyclical recoveries.

The ECB has never claimed that its strategy is the ultimate solution to the challenges monetary policy is confronted with. But, it has recognised the need to include monetary analysis in a very broad sense into its policy considerations.

CAMBRIDGE In its September policy statement, the US Federal Reserve took into consideration in a major way the impact of global economic developments on the United States, and thus on US monetary policy. Indeed, the Fed decided to delay raising interest rates partly because US policymakers expect dollar appreciation, by lowering import prices, to undermine their ability to meet their 2 inflation target.

The US could no longer maintain a fixed exchange rate between the dollar and gold the cornerstone of the postwar Bretton Woods system. The arrangement collapsed because the US did not want to tighten monetary policy and run more restrictive fiscal policy keeping US voters happy was understandably more important to President Nixon than maintaining a global system of fixed exchange rates.

In China, unlike in advanced countries, monetary and sterilization policy are often one in the same. The degree to which monetary policy is expansionary depends on the degree to which the liquidity created by currency market intervention has been sterilized.

Fourth, central banks, especially in the US, mistakenly maintained loose monetary policy. With dollar financing by the Federal Reserve available to large institutions, the Fed became the equivalent of a world central bank.

The International Monetary Fund continued to assist the Government, through a close policy dialogue, in maintaining macroeconomic stability, especially in the area of fiscal policy.

This is not to say that sudden normalization of monetary policy is a good idea. But, if large scale investment and reform programs were initiated as complements to unconventional monetary policy measures, the economy could move onto a more resilient growth path.

Looser US monetary policy has thus set the tempo for inflation in a significant chunk perhaps as much as 60 of the global economy. But, with most economies in the Middle East and Asia in much stronger shape than the US and inflation already climbing sharply in most emerging market countries, aggressive monetary stimulus is the last thing they need right now.

The German fascination with gold is a red herring. Its fear of wayward monetary policy is not.

In principle, the answer is straightforward. If a central bank has two policy targets, then it needs two instruments monetary policy to influence aggregate demand, and regulatory policy to limit financial risks.

Crisis management has resulted in major market distortions, with some segments performance no longer explainable by fundamental economic data. The unintended consequences of this policy are increasingly visible and will become increasingly tangible with the US Federal Reserve s exit from post 2008 ultra loose monetary policy.

The ghost of Franklin Delano Roosevelt haunts Barack Obama s United States. Historical arguments over whether FDR s New Deal worked now form an important part of American debates over current monetary and fiscal policy in general, and the US Federal Reserve s policy of quantitative easing in particular.

The US will normalize its interest rate policy sooner or later according to its need. For other countries, it is important to focus on policies that can strengthen resilience to foreign financial or monetary shocks.