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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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1099.

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Date of creation: Jan 1995
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Handle: RePEc:cpr:ceprdp:1099

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Keywords: Price Stability; Real Interest Rates; Risk Premium; Targeting Procedures;

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References

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  1. Reuven Glick & Kenneth Rogoff, 1992. "Global versus country-specific productivity shocks and the current account," Working Papers in Applied Economic Theory 92-06, Federal Reserve Bank of San Francisco.
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  7. Matthew B. Canzoneri & Dale W. Henderson & Kenneth S. Rogoff, 1981. "The information content of the interest rate and optimal monetary policy," International Finance Discussion Papers 192, Board of Governors of the Federal Reserve System (U.S.).
  8. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
  9. Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
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  11. 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.).
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Citations

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Cited by:
  1. Collard, Fabrice & Dellas, Harris & Ertz, Guy, 2000. "Poole Revisited," CEPR Discussion Papers 2521, C.E.P.R. Discussion Papers.
  2. Elisa Newby, 2009. " The Suspension of the Gold Standard as Sustainable Monetary Policy," CDMA Conference Paper Series 0907, Centre for Dynamic Macroeconomic Analysis.
  3. 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.
  4. Richard H. Clarida, 2013. "Hot Tip: Nominal Exchange Rates and Inflation Indexed Bond Yields," NBER Working Papers 18726, National Bureau of Economic Research, Inc.
  5. Elisa Newby, 2007. "The Suspension of Cash Payments as a Monetary Regime," CDMA Working Paper Series 200707, Centre for Dynamic Macroeconomic Analysis.
  6. Kevin Salyer & Harris Dellas, 2003. "Some Fiscal Implications of Monetary Policy," Working Papers 21, University of California, Davis, Department of Economics.
  7. 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).
  8. Padrini, Flavio, 2002. "Velocity innovations, financial markets, and the real economy," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 521-532, April.
  9. 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.
  10. 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.
  11. Flavio Padrini, 1997. "Efficiency Of The Payments System, Velocity Of Circulation Of Money, And Financial Markets," Macroeconomics 9706004, EconWPA.
  12. 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.
  13. Woon Gyu Choi & Michael B. Devereux, 2005. "Asymmetric Effects of Government Spending," IMF Working Papers 05/7, International Monetary Fund.

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