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Real interest rates and central bank operating procedures

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  • Canzoneri, Matthew B.
  • Dellas, Harris

Abstract

In the years following the influential article of Poole (1970), many central banks reoriented their operating procedures to focus more on interest rates and less on monetary aggregates. The rapid restructuring of global financial markets was thought to have led to instability in standard monetary relationships, and Poole's basic insight suggested that a central bank would have better control of the price level if it targeted nominal interest rates instead of monetary aggregates. At the same time, there is a common perception that real interest rates have risen. This paper uses general equilibrium models to suggest that the switch in operating procedures may have caused a bias towards higher real interest rates and (rather perversely) less stable prices. Our model calibrations imply that US real interest rates might be 50 to 100 basis points lower, and prices might be 30-40% more stable, if the Fed switched its focus away from the nominal interest rate and targeted M1 instead. (These estimates assume a coefficient of relative risk aversion between 2.5 and 3.5.) Nominal income targeting would be a good compromise.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 42 (1998)
Issue (Month): 3 (October)
Pages: 471-494

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Handle: RePEc:eee:moneco:v:42:y:1998:i:3:p:471-494

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Carlstrom, Charles T. & Fuerst, Timothy S., 1995. "Interest rate rules vs. money growth rules a welfare comparison in a cash-in-advance economy," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 247-267, November.
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  8. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, . "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 7-89, Wharton School Rodney L. White Center for Financial Research.
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  10. Marvin Goodfriend & David H. Small (), 1993. "Operating procedures and the conduct of monetary policy: conference proceedings," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  11. Canzoneri, Matthew B & Henderson, Dale W & Rogoff, Kenneth S, 1983. "The Information Content of the Interest Rate and Optimal Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 545-66, November.
  12. Litzenberger, Robert H & Ronn, Ehud I, 1986. " A Utility-based Model of Common Stock Price Movements," Journal of Finance, American Finance Association, vol. 41(1), pages 67-92, March.
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Citations

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Cited by:
  1. Elisa Newby, 2007. "The Suspension of Cash Payments as a Monetary Regime," CDMA Working Paper Series 200707, Centre for Dynamic Macroeconomic Analysis.
  2. Padrini, Flavio, 2002. "Velocity innovations, financial markets, and the real economy," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 521-532, April.
  3. Peter Smith, 2010. "Discussion of the Fisher Effect Puzzle: A Case of Non-Linear Relationship," Open Economies Review, Springer, vol. 21(1), pages 105-108, February.
  4. Elisa Newby, 2009. " The Suspension of the Gold Standard as Sustainable Monetary Policy," CDMA Conference Paper Series 0907, Centre for Dynamic Macroeconomic Analysis.
  5. Jana Hromcová, 2004. "On The Income Velocity Of Money In A Cash-In-Advance Economy With Capital," Working Papers. Serie AD 2004-21, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  6. Flavio Padrini, 1997. "Efficiency Of The Payments System, Velocity Of Circulation Of Money, And Financial Markets," Macroeconomics 9706004, EconWPA.
  7. Richard H. Clarida, 2013. "Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields," NBER Working Papers 18726, National Bureau of Economic Research, Inc.
  8. Woon Gyu Choi & Michael B. Devereux, 2005. "Asymmetric Effects of Government Spending," IMF Working Papers 05/7, International Monetary Fund.
  9. Gulbin Sahinbeyoglu, 2001. "Monetary Transmission Mechanism : A View From A High Inflationary Environment," Discussion Papers 0101, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  10. Jordi Caballé & Jana Hromcová, 2011. "The Role of Central Bank Operating Procedures in an Economy with Productive Government Spending," Computational Economics, Society for Computational Economics, vol. 37(1), pages 39-65, January.
  11. Collard, Fabrice & Dellas, Harris & Ertz, Guy, 2000. "Poole Revisited," CEPR Discussion Papers 2521, C.E.P.R. Discussion Papers.
  12. Harris Dellas & Kevin D. Salyer, 2003. "Some Fiscal Implications of Monetary Policy," Bulletin of Economic Research, Wiley Blackwell, vol. 55(1), pages 21-36, January.
  13. Hromcova, Jana, 2003. "Money and growth in a cash-in-advance economy with costly credit," Economic Modelling, Elsevier, vol. 20(6), pages 1113-1136, December.

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