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Central Bank Policy in a More Perfect Financial System

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Author Info
Jürgen Von Hagen
Ingo Fender

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Abstract

Financial innovation increases markets' liquidity and provides economic agents with new instruments to better handle risks, but it reduces the efficacy of monetary policy while strengthening the logic and force of the “unholy trinityâ€. Increased liquidity of financial markets and increased leverage of financial positions imply that speculators can attack unsustainable fixed exchange rates faster and more powerfully than ever. The rapid innovation of new financial instruments in these markets also implies the futility to “throw sand in the wheels†through regulation or the introduction of transaction taxes. The higher asset substitutability generated by the emergence of derivatives makes the definition of “money,†particularly of broad monetary aggregates, increasingly difficult. In a more complete financial market system central banks find it harder to predict the effect of a given monetary impulse on real output and employment with any reasonable precision. Discretionary monetary policies aimed at output and employment become more uncertain. Consequently, central banks should focus on the long-run goal of price stability. Copyright Kluwer Academic Publishers 1998

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Article provided by Springer in its journal Open Economies Review.

Volume (Year): 9 (1998)
Issue (Month): 1 (January)
Pages: 493-532
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Handle: RePEc:kap:openec:v:9:y:1998:i:1:p:493-532

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Related research
Keywords: financial innovation; derivatives; effectiveness of monetary policy; transmission mechanism; financial crises; financial regulation;

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Paolo Savona & Aurelio Maccario & Chiara Oldani, 2000. "On Monetary Analysis of Derivatives," Open Economies Review, Springer, vol. 11(1), pages 149-175, August. [Downloadable!] (restricted)
  2. Michele Fratianni & Dominick Salvatore & Paolo Savona, 1998. "Ideas for the Future of the International Monetary System: Conclusions and Remarks," Open Economies Review, Springer, vol. 9(1), pages 689-700, January. [Downloadable!] (restricted)
  3. French-German Economic Forum, 1999. "Economic Policy Coordination - Financial Supervision in the EMU," Working Papers 1999-04, CEPII research center. [Downloadable!]
  4. Esteban Gómez & Diego Vásquez & Camilo Zea, 2005. "Derivative Markets' Impact On Colombian Monetary Policy," BORRADORES DE ECONOMIA 002277, BANCO DE LA REPÚBLICA. [Downloadable!]
    Other versions:
  5. Paolo Savona & Aurelio Maccario, 1998. "On the Relation between Money and Derivatives and its Application to the International Monetary Market," Open Economies Review, Springer, vol. 9(1), pages 637-664, January. [Downloadable!] (restricted)
  6. Chiara Oldani, 2005. "An Overview of the Literature about Derivatives," Macroeconomics 0504004, EconWPA. [Downloadable!]
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