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Central bank power is a matter of faith

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  • Bengtsson, Ingemar

    ()
    (Department of Economics, Lund University)

Abstract

This paper reconsiders how central banks get involved in the process of determining nominal variables such as market interest rates and inflation rates. It is argued that the traditional story deriving central bank power from its monopoly of issuing base money is flawed. That story - in its various guises - is based on the quantity equation. This equation, however, is only applicable in the hypothetical only-cash-world, i.e. in a world where all transactions has to be paid for with central bank issued notes and coins. Nevertheless, the vast majority of economists would agree that, in practice, central banks seem to influence interest and inflation rates. Here, we suggest that the explanation is that central banks have acquired a role as focal point for those variables. It is possible because interest setting is a coordination game, in which agents have to predict each others expectations.

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Bibliographic Info

Paper provided by Lund University, Department of Economics in its series Working Papers with number 2005:21.

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Length: 18 pages
Date of creation: 04 Mar 2005
Date of revision:
Publication status: Published in The ICFAI Journal of Monetary Economics, 2005, pages 70-84.
Handle: RePEc:hhs:lunewp:2005_021

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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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Related research

Keywords: Central Banking; Focal Points; Inflation; Monetary Policy; Money; Quantity Theory;

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References

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  1. Cowen, Tyler & Kroszner, Randall, 1987. "The Development of the New Monetary Economics," Journal of Political Economy, University of Chicago Press, vol. 95(3), pages 567-90, June.
  2. Fama, Eugene F., 1980. "Banking in the theory of finance," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 39-57, January.
  3. Friedman, Benjamin M, 1999. "The Future of Monetary Policy: The Central Bank as an Army with Only a Signal Corps?," International Finance, Wiley Blackwell, vol. 2(3), pages 321-38, November.
  4. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
  5. Michael Woodford, 2000. "Monetary Policy in a World Without Money," NBER Working Papers 7853, National Bureau of Economic Research, Inc.
  6. Benjamin M. Friedman, 1999. "The Future of Monetary Policy: The Central Bank as an Army With Only a Signal Corps," NBER Working Papers 7420, National Bureau of Economic Research, Inc.
  7. Hall, Robert E, 1982. "Monetary Trends in the United States and the United Kingdom: A Review from the Perspective of New Developments in Monetary Economics," Journal of Economic Literature, American Economic Association, vol. 20(4), pages 1552-56, December.
  8. Charles Goodhart, 2000. "Can Central Banking Survive the IT Revolution?," FMG Special Papers sp125, Financial Markets Group.
  9. Goodhart, Charles A E, 2000. "Can Central Banking Survive the IT Revolution?," International Finance, Wiley Blackwell, vol. 3(2), pages 189-209, July.
  10. Greenfield, Robert L & Yeager, Leland B, 1983. "A Laissez-Faire Approach to Monetary Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 15(3), pages 302-15, August.
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Cited by:
  1. Bengtsson, Ingemar, 2005. "A framework for understanding inflation - with or without money," Working Papers 2005:28, Lund University, Department of Economics.
  2. Bengtsson, Ingemar, 2005. "Transaction Costs, Money and Units of Account," Working Papers 2005:29, Lund University, Department of Economics.

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