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Central Bank Financial Strength and Credibility: A Simple Dynamic Optimization Model

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  • Atsushi Tanaka

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    (School of Economics, Kwansei Gakuin University)

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    Abstract

    In this paper, we develop a simple dynamic optimization model of a central bank, in which the bank’s profit affects its balance sheet. The model derives the transversality condition that is necessary for a central bank to be sustainable and to conduct an optimal monetary policy. In this sense, the transversality condition needs to be satisfied to maintain central bank credibility. We discuss some factors affecting the transversality condition and show that what is important to satisfy the condition and thus to maintain central bank credibility is not capital alone but the financial strength that generates no sustained loss.

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    File URL: http://192.218.163.163/RePEc/pdf/kgdp102.pdf
    File Function: First version, 2013
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    Bibliographic Info

    Paper provided by School of Economics, Kwansei Gakuin University in its series Discussion Paper Series with number 102.

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    Length: 17 pages
    Date of creation: Mar 2013
    Date of revision: Mar 2013
    Handle: RePEc:kgu:wpaper:102

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    Keywords: central bank; capital; financial strength; credibility; monetary policy;

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    1. Alain Ize, 2005. "Capitalizing Central Banks," IMF Working Papers 05/15, International Monetary Fund.
    2. Martin Cincibuch & Tomas Holub & Jaromir Hurnik, 2008. "Central Bank Losses and Economic Convergence," Working Papers 2008/3, Czech National Bank, Research Department.
    3. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
    4. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
    5. Alain Ize, 2005. "Capitalizing Central Banks: A Net Worth Approach," IMF Staff Papers, Palgrave Macmillan, vol. 52(2), pages 289-310, September.
    6. Peter Stella & Ulrich H. Klueh, 2008. "Central Bank Financial Strength and Policy Performance," IMF Working Papers 08/176, International Monetary Fund.
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