mprcb course outline 1213

7/28/2019 MPRCB Course Outline 1213

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Centre for Development Studies

Monetary Policy and the Role of Central Banks (ECON 5024)

Course outline 2012/13Semester one

Course convenor: Professor Campbell LeithCourse lecturers: Professor Campbell Leith and Dr Tatiana Kirsanova

Brief descriptionThis course is a core course for students studying for the MSc / DiplomaInternational Banking and Finance and for the MSc / Diploma Economics, Bankingand Finance.

The course begins by considering the goals of monetary policy, in the context ofdeveloped and developing countries. Contemporary macroeconomic theory is usedto define what is achievable through monetary policy. The course then considersthe instruments available to the monetary authorities to achieve these aims, andassesses the relative merits of these approaches to the implementation of monetarypolicy. Next we examine the monetary transmission mechanism. The courseconcludes by looking at issues in the design of optimal monetary policy institutions,at the time-inconsistency problem and at the desirability of inflation targeting and /or an independent central bank.

AimsThe main aims of the course are to:

Outline the goals of monetary policy. Review the instruments available to central banks for the achievement of these

goals.

Give an overview of the implementation of monetary policy in practice.

Consider a number of issues relating to the optimal design of monetary policyinstitutions and the conduct of monetary policy.

Learning objectivesBy the end of this course, students should be able to:

Outline and give a detailed justification of the main goals of monetary policy. Evaluate the ability of different monetary policy instruments to achieve these

goals. Review and assess the experience of a range of economies in conducting

monetary policy. Explain the difficulties in designing optimal monetary policy and assess

alternative solutions to these problems.


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AssessmentThis course is assessed by a combination of end-of-course examination (75 percent) and in-course assessment (25 per cent). The end-of-course examination istaken in the April/May diet examinations, and takes the form of a two-hour paper,with students being required to answer two questions from a list of four. In-courseassessment takes the form of an essay.

In Course Assessment Essay Question:Describe the policies of Quantitative Easing pursued by the US Fed and the Bank ofEngland and assess their effectiveness. Would a new round of such policies ineither country be as effective as earlier rounds?

Essays should be typed, double line spaced, with font size 12. The essay shouldbe no more than 2,000 words in length. Details of the submission procedures anddeadline will be provided nearer the time.

Penalty for latenessPenalties for late submission of coursework apply. Please refer to the MSc

handbook.

Teaching methodsAs there are no tutorials, students are strongly encouraged to make use of e-mailsand the lecturers office hours to clarify any points that were not made absolutelyclear during the lectures. We may also make use of some of class teaching time toallow students to give informal group presentations on topics covered in the class.

TimetableThe class will meet for a total of twenty hours during Semester 1. There will be onetwo-hour lecture weekly for ten weeks. There are no tutorials.

Texts/additional readingThere is no text recommended for purchase, as no single textbook is appropriate forthe whole course. A wide range of reading material will be referred to includingrelevant journal articles. Detailed reading guides are included below.


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Lecture outline

Lecture 1: Introduction an overview of issues covered in the course

The first lecture will deal with administrative matters and give an overview of thecontent of this course.

Lectures 2-5: The goals of monetary policy

These lectures will examine the final goals commonly assigned to monetary policy price stability and contributing to the governments finances. We shall begin byreviewing why contemporary macroeconomic theory suggests that monetary policyshould not attempt to boost output, but should, instead, concentrate on stabilisingprices. To do so we shall focus on the labour market behaviour underlying thePhillips Curve and consider the role of expectations in defining any trade-offbetween inflation and unemployment. We shall then consider the role of monetarypolicy in financing government expenditure, and the implications this has for pricestability.

Lecture learning objectives

At the end of this group of lectures students should be able to:

Describe the main goals of monetary policy. Using contemporary macroeconomic theory and empirical evidence, critically

assess the motivations for these objectives. Analyse the relative importance of these objectives across different

economies.

Suggested readingThe Federal Reserve Board of San Francisco publishes a journal Economic Letter

on-line at:

http://www.frbsf.org/publications/economics/letter/index.html

These articles are usually very brief (around 4 / 5 pages) and offer non-technicalsummaries of recent research by leading economists. They are an excellentstarting point for your reading before you consider the more technical material, andit is worthwhile to browse other issues not listed here. Non-technical accounts onthe nature of the output-inflation trade-off appear in various issues of EconomicLetter:

Trehan, B. (1999). Economic activity and inflation, Economic Letter, No. 99-09.

Walsh, Carl E. (1998). Nobel views on inflation and unemployment, EconomicLetter, No. 97-01; January 10.

Walsh, Carl E. (1998). The new output-inflation trade-off, Economic Letter, No 98-04, February.

Friedmans view of the labour market behaviour implied by the Phillips curve isdiscussed in:

Carlin, W. and Soskice, D. (1990). Macroeconomics and the Wage Bargain,Chapter 3, London: Oxford University Press.


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The optimal rate of inflation is discussed in:

Cogley, T. (1997). What is the optimal rate of inflation?, Economic Letter, No. 97-27.

Walsh, Carl E. (1998). Nobel views on inflation and unemployment, Economic

Letter, No. 97-01.

Marquis, M. (2001). Inflation: the 2% solution, Economic Letter, No. 2001-03.

The evolution of the goals of monetary policy in the US is discussed in:

Judd, J.P. and Rudebusch, G.D. (1997). The goals of US monetary policy,Economic Letter, No. 97-04.

The difference between price-level targeting and inflation-targeting is considered by:

Walsh, C.E. (2000). Should central banks stabilize prices?, Economic Letter, No.2000-24.

To understand the link between monetary policy and government finances it isnecessary to understand the governments budget constraint. This is discussed in:

Mankiw, N.G. (2000). Macroeconomics, 4th edition, Worth Publishers, Chapter 15.

Leslie, D. (1993). Advanced Macroeconomics: Beyond IS / LM, McGraw-HillInternational (UK) Ltd., Chapter 1.

A non-technical paper which deals with the links between monetary policy andgovernment debt and some empirical illustrations of those theories can be found in:

Dornbusch, R. (1996). Debt and Monetary Policy: The Policy Issues, NationalBureau of Economic Research, Working Paper No. 5573. This is downloadablefrom http://papers.nber.org/.

The importance of the fiscal consequences of monetary policy in developingcountries is discussed in:

Fry, M.J. (1995). Money, Interest and Banking in Economic Development, The JohnHopkins University Press, Chapter 17, Central banks and deficit finance indeveloping countries.

Lectures 6-8: The instruments of monetary policy

These lectures will discuss the various direct controls and indirect instrumentsavailable to a central bank. We shall examine how each instrument is implementedand we shall examine the relative merits of direct controls in comparison with moremarket-based approaches.



Describe the main instruments of monetary policy.

Analyse the relative merits of these instruments both within and acrossdifferent economies.

Suggested reading


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The Bank of England also publishes a number of fact-sheets on central bankingpractice which are very useful. These can be downloaded from the Bank ofEngland at:

http://www.bankofengland.co.uk/education/ccbs/handbooks/index.htm:

Allen, W. (2004). Implementing Monetary Policy, Handbooks in Central Banking,Lecture Series #4, Bank of England.

http://www.bankofengland.co.uk/education/ccbs/ls/lshb04.htm

Gray, S. and Talbot, N. (2006). Monetary Operations, Handbooks in CentralBanking, #24, Bank of England.

http://www.bankofengland.co.uk/education/ccbs/handbooks/pdf/ccbshb24.pdf

Alexander, W. et al. (1996). Adopting indirect instruments of monetary policy,Finance and Development, vol. 33(1), (March), pp. 14-17.

http://www.imf.org/external/pubs/ft/fandd/1996/03/pdf/alexande.pdf

Gray, S. et al. (2002). Introduction to Monetary Operations, 2nd edition, Handbooksin Central Banking, #10, Bank of England.http://www.bankofengland.co.uk/education/ccbs/handbooks/ccbshb10.htm

IMF (2004). Monetary Policy Implementation at Different Stages of MarketDevelopment. http://www.imf.org/external/np/mfd/2004/eng/102604.htm

The relative merits of setting interest rates or targeting quantities are discussed in:

Schaechter, A. (2001). Implementation of Monetary Policy and the Central Banks

Balance Sheet, IMF Working Paper #149.

http://www.imf.org/external/pubs/ft/wp/2001/wp01149.pdf

The implementation of monetary policy is covered in:

Handa, J. (2000). Monetary Economics, Routledge, Chapters 10-12.

Lewis, M.K. and Mizen, P.D. (2000). Monetary Economics, Oxford University Press,Chapter 14.

Lectures 9-10: The Credit Crunch

This lecture will explore the cause of the recent credit crunch and its implications forthe conduct of monetary policy.


At the end of this lecture students should be able to:

Outline the process of securitisation and the leveraged yield tradingundertaken by banks.

Explain how this contributed to the credit crunch and assess the policyresponse to this credit market failure.

Suggested reading:

An excellent and relatively non-technical book on the crisis is:


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Milne, Alistair, (2009). The Fall of the House of Credit, Cambridge University Press.

Another book focusing on the personalities involved is:

Tett, Gillian, (2009). Fools Gold. How unrestrained greed corrupted a dream,shattered global markets and unleashed a catastrophe, Little Brown.

A thought-provoking book which explores the underlying macroeconomic andpolitical economy causes of the financial crisis is:

Rajan, R. G. (2010), Fault Lines: How Hidden Fractures Still Threaten the WorldEconomy, Princeton University Press.

An early empirical analysis can be found in:

Taylor, J. and Williams, J. (2008), 'A Black Swan in the Money Market', NBERworking paper No. 13943.

This paper has been published in the American Economic Journal:

Taylor, John B., and Williams. John C. (2009). A black swan in the money market,American Economic Journal: Macroeconomics, 1(1): 5883.

An analysis of past crises is given in:

Laeven, L and Valencia, F. (2008). 'Systemic Banking Crises: A New Database',IMF Working Paper No. 224, September 2008.

The US Feds policy response is detailed on their website:

http://www.federalreserve.gov/monetarypolicy/bst.htm

and the Bank of Englands policy of Quantitative Easing is detailed at:

http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm

and a detailed comparison of the policies of the US Fed, the ECB and the Bank ofEngland can be found in:

Lenza, M, H. Pill and L. Reichlin (2010), Monetary Policy in Exceptional Times,Economic Policy, April 2010, pp 295-339.

A brief summary of work assessing the impact of quantitative easing can be foundat:

Williams, J. (2011), Unconventional Monetary Policy: Lessons from the Last ThreeYears, FRBSF Economic Letter, No. 2011-31.

And a summary of a Bank of England conference on unconventional monetarypolicy which details some of the policies pursued in the US Fed, ECB and Bank ofEngland:

Joyce, M. (2012), Quantitative Easing and Other Unconventional MonetaryPolicies: Bank of England Conference Summary, Quarterly Bulletin, Q1, pp 48-55.

http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb120104.pdf


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Moving from direct controls to a market based system

In previous years we looked at the issues that arise when developing economiesattempt to move from a system of direct to indirect, market-based controls for theconduct of monetary policy. We also examined the empirical evidence on theviability and success of alternative approaches. However, due to the increased

attention paid to the financial crisis and the fact that most economies have movedtowards the use of indirect instruments, we shall no longer teach or examine thistopic. Nevertheless, the suggested reading materials are given below just in casethey are of interest.

Suggested reading

IMF (2004). Monetary Policy Implementation at Different Stages of MarketDevelopment.

http://www.imf.org/external/np/mfd/2004/eng/102604.htm.

Schaechter, A. (2001). Implementation of Monetary Policy and the Central BanksBalance Sheet, IMF Working Paper #149.

http://www.imf.org/external/pubs/ft/wp/2001/wp01149.pdf.

Alexander, W. et al. (1996). Adopting indirect instruments of monetary policy,Finance and Development, vol. 33(1), (March), pp. 14-17.

Other potential sources of material:

Honohan, P. and OConnel, S.A. (1997). Contrasting Monetary Regimes in Africa,IMF Working Paper No. 97 / 64, May 1997.

Wagner, H. (1997). Central Banking in Transition Economies, IMF Working PaperNo. 98 / 126, August 1997.

The Development of Bond Markets in Emerging Economies, BIS Papers No. 11.

Lectures 11 14:From instruments to goals the monetary policytransmission mechanism

Having outlined both the aims and instruments of monetary policy, we shall turn tothe link between the two the monetary policy transmission mechanism. We shallalso examine the role of intermediate targets. In addition, we shall study the impactthat the recent financial crisis had on the transmission mechanism, and thetransmission mechanism of unconventional monetary policies.



Provide a detailed analysis of the linkages between monetary policyinstruments and the goals of monetary policy.

Understanding the impact that the financial crisis had on the monetary policytransmission mechanism.

Understanding the policy transmission mechanism of unconventionalmonetary policies.

Suggested reading


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Information on the monetary policy transmission mechanism is published by:

Bank of England Monetary Policy Committee (1999). The transmission mechanismof monetary policy.

This can also be found at the Bank of England's website at:

http://www.bankofengland.co.uk/publications/other/monetary/montrans.pdf and itconsiders both the theoretical and empirical aspects of the transmissionmechanism.

See also the HM Treasury study EMU and the monetary transmission mechanism,Chapter 2, for a review of the theory of the Transmission Mechanism, and Chapter4 for a comparison of differences across countries.

http://www.hm-treasury.gov.uk/documents/international_issues/the_euro/assessment/studies/euro_assess03_studhampshire.cfm

Other papers relevant to the monetary transmission mechanism can be found inSymposium on the Monetary Transmission Mechanism, Journal of EconomicPerspectives(1995), vol. 9(4). In particular see the papers by:

Taylor, J.B. (1995). The monetary transmission mechanism: an empiricalframework.

Bernanke, B.S. and Gertler, M. (1995). Inside the black box: the credit channel ofmonetary policy transmission.

Another paper which examines the transmission mechanism is:

Taylor, M.P. (1999). Real interest rates and macroeconomic activity, Oxford

Review of Economic Policy, vol. 15(2), pp. 95-113.

A paper on the evolution of the monetary policy transmission mechanism:

Boivin, J., Kiley MT and Mishkin, F.S. (2010) "How Has the Monetary TransmissionMechanism Evolved Over Time?," NBER Working Papers15879.Papers on the financial crisis, unconventional monetary policies and theirtransmission mechanism:

Cecchetti, S. (2009) Crisis and responses: the Federal Reserve in the early stagesof the financial crisis Journal of Economics perspectives, vol 23(1), pp 51-75. Thispaper uses the balance sheet of the Federal Reserve to demonstrate the

differences between conventional and unconventional monetary policies.

Benford, J., Berry, S., Nikolov, K., Young, C. and Robson, Mark (2009).Quantitative easing Bank of England Quarterly Bulletin, pp 90-100. This articleoutlines the three main transmission channels for QE.

Joyce, M.,Lasaosa, A., Stevens , I. & Tong, M., (2010) "The financial market impactof quantitative easing," Bank of England working papers 393. This paper details theimpact of QE through the asset pricing channel.

Meier, A. (2009). Panacea, Curse, or Nonevent? Unconventional Monetary Policyin the United Kingdom. IMF Working Paper 09/163. This paper outlines a range of

unconventional monetary policy options, and the transmission channels and risksassociated with each. It also focuses on the BoEs specific policies and their


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effectiveness.

Borio, C. and Disyatat, P. (2010) Unconventional Monetary Policies: An Appraisal,Manchester School, 78(s1), pp. 53-89. This paper provides a technical descriptionof unconventional monetary policies (i.e. the balance sheet policies) and theirtransmission mechanism.

European Central Bank (2010) The ECBs Response to the Financial Crisis. ECBMonthly Bulletin, pp 59-74. This paper provides an overview of monetary policytransmission in the Euro Area in normal times and the effect of the financial crisishad on the transmission channels. It also provides the ECBs assessment of theirresponse to the crises.

Lectures 15-16: How central banks behave in practice - case studies

The lectures so far will have developed a basic framework for analysing the conductof monetary policy. These lectures will utilise this framework to examine thepractice of a number of central banks from both developed and developing

countries. We shall also examine the empirical evidence on the transmissionmechanism for a range of countries.



Provide a detailed review of the actual conduct of monetary policy in anumber of developed, developing and emerging economies.

Explain the differences in the conduct of monetary policy in the light of thediscussion of the links between goals and instruments undertaken above.

Suggested readingAs a framework for comparing the actual setting of interest rates in the US, Japanand Europe we shall examine the econometric approach of:Clarida, R., Gali, J. and Gertler, M. (1998). Monetary policy rules in practice: someinternational evidence, European Economic Review, vol. 42(6), (June), pp. 1033-1068.

For a discussion of Taylor Rules:Orphanides, A. (2007) Taylor Rules. The New Palgrave: A Dictionary of Economics.Second Editionhttp://www.athanasiosorphanides.com/taylor22f.pdf

In this subsection a relevant article from the journal describing US monetary policyis:

Economic Research Department, (1999). US monetary policy: an introduction,FRBSF, Economic Letter, No. 99-01.

Marquis, M. (2002). Setting the interest rate, Economic Letter, No. 2002-30.

The African case is dealt with in:

Honohan, P. and OConnel, S.A. (1997). Contrasting Monetary Regimes in Africa,IMF Working Paper No. 97 / 64, Pay 1997.


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A comparison of the US, Japan and the Euro-area is given in:

Monetary and Economic Department (2001). Comparing Monetary Policy OperatingProcedures across the United States, Japan and the Euro-Area, BIS Papers No. 9.

Lecture 17: Understanding monetary statistics

This lecture will provide students with a guide to official monetary statistics.


At the end of this lecture students should:

Have knowledge of the usefulness of a range of standard monetarystatistics.

Explain the role of economic models in implementing monetary policy.

Suggested reading

The core reading for this lecture is the Centre for Central Banking StudiesHandbook:

Thorp, J. and Turnbull, P. (2000). Banking and Monetary Statistics, Centre forCentral Banking Studies Handbook in Central Banking.

We shall also discuss the use of models in implementing monetary policy:

Price, L. (1996). Economic Analysis in a Central Bank Models versus Judgement,Centre for Central Banking Studies, Handbook in Central BankingNo. 3.

We shall then examine the practice in the Bank of England as a case study. Therange of models employed by the Bank of England is discussed in:

Economic Models at the Bank of England, (1999 and updated 2000). Pub. Bank ofEngland. Downloadable from the Bank of Englands website,http://www.bankofengland.co.uk andhttp://www.bankofengland.co.uk/publications/other/beqm/models00.pdf.

We shall also examine the Pagan reports into the use of such models at the Bank:

Pagan, A. (2003). Report on Modelling and Forecasting at the Bank of England.Downloadable from

http://www.bankofengland.co.uk/publications/news/2003/paganreport.pdf.

Lecture 18-20: Other issues in monetary policy design

In these lectures we shall look at the problem of time-inconsistency. In other words,even if policy makers accept the desirability of price-stability, they may haveincentives to renege on their promises to act accordingly. We shall also look atpossible solutions to these problems, and review the evidence on the success ofthese solutions. We shall also examine the implications for monetary policy ofinteractions between monetary and fiscal policy.


At the end of these lectures students should be able to:

Outline the problem of time-inconsistency as it applies to monetary policy. Critically evaluate solutions to this problem.


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Assess the importance of monetary and fiscal policy interactions.

Comment on the optimal design of monetary policy institutions in differenteconomies.

Suggested reading

For time inconsistency:

Beddies, C.H. (2000). Selected Issues Concerning Monetary Policy and InstitutionalDesign for Central Banks: A Review of Theories. IMF Working Paper # 00 / 140.

Carlin, W. and Soskice, D. (2006). Macroeconomics: Imperfections, Institutions andPolicies, Oxford University Press, Chapter 5, Monetary Policy.

http://www.oup.com/uk/orc/bin/9780198776222/carlin_chap05.pdf

Walsh, C. (2003). Modern Central Banking: An Academics Perspective.

http://people.ucsc.edu/~walshc/MyPapers/ModernCentralBankingfinal.pdfFor the interaction between monetary and fiscal policy:

Balls, E. and ODonnell, G. (2002). Reforming Britains Economic and FinancialPolicy, Chapter 5, Policy coordination, HM Treasury.

HM Treasury (2003). Policy Frameworks in the UK and EMU, Chapter 5, PolicyCoordination. http://www.hm-treasury.gov.uk/media/0/1/adsur03_4567ra_289.pdf

Bhundia, A. and ODonnell, G. (2002.) UK policy coordination: the importance ofinstitutional design, Fiscal Studies, vol. 23(1), (March), pp. 135-164.

The three papers listed above were produced by the previous UK Government. Thematerial on fiscal and monetary policy coordination remains relevant; however thewider discussion on the UK Governments fiscal policy framework and targets isnow out of date. For an overview of the new UK Governments fiscal frameworkand objectives, please see:

HM Treasury - Budget 2010 (pp 11-13)

http://cdn.hm-treasury.gov.uk/junebudget_complete.pdf

HM Treasury - Charter for Budget Responsibility (Chapters 3 and 4)

http://www.hm-treasury.gov.uk/d/charter_budget_responsibility040411.pdf

IFS Green Budget Charter 2 - The new fiscal framework: an assessmenthttp://www.ifs.org.uk/budgets/gb2011/11chap2.pdf

Nordhaus, W. (1994). Policy games: coordination and independence in monetaryand fiscal policies, Brookings Papers on Economic Activity2, pp. 139-216.

For a discussion of different nominal anchors and inflation targeting:

Batini, N., Kuttner, K. and Laxton, D. (2005). Does inflation targeting work inemerging markets?,IMF World Economic Outlook, Sept 2005.

http://www.imf.org/external/pubs/ft/weo/2005/02/pdf/chapter4.pdf.Bernanke, B. et al. (1999). Inflation Targeting: Lessons from the International


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Experience, Princeton (pp. 301-307 on other nominal anchors).

Kahn, M.S. (2003). Current Issues in the Design and Conduct of Monetary Policy,IMF Working Paper # 03 / 56.

http://www.imf.org/external/pubs/ft/wp/2003/wp0356.pdf.

For other material on this topic:

A comprehensive, yet readable, review of the literature discussing the credibility ofmonetary policy announcements under rational expectations (time consistency /inconsistency) is given in:

Lewis, M.K. and Mizen, P.D. (2000). Monetary Economics, Oxford University Press,Chapter 10.

A summary of recent research on time-inconsistency is given by:

Dennis, R. (2003). Time-inconsistent monetary policies: recent research, FRBSF,

Economic Letter, No. 2003-10.

Transparency and monetary policy is discussed in:

Walsh, C.E., (2000). Uncertainty and monetary policy, Economic Letter, No. 2000-08.

Walsh, C.E. (2001). Transparency in monetary policy, Economic Letter, No. 2001-26.

Issues relating to applying inflation targeting in developing countries are dealt within:

Carare, A., Schaechter, A., Stone, M. and Zelner, M. (2002). Establishing InitialConditions in Support of Inflation Targeting, IMF Working Paper 20 02 / 102, June2002.

The experience of developing economies adopting inflation targeting is reviewed in:

Carare, A. and Stone, M.R. (2002). Inflation Targeting Regimes, IMF WorkingPaper 03 / 09, January 2003.