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On the (non-)equivalence of capital adequacy and monetary policy: A response to Cechetti and Kohler

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  • Stan du Plessis

    ()
    (Department of Economics, University of Stellenbosch)

  • Gideon du Rand

    ()
    (Department of Economics, University of Stellenbosch)

Abstract

The instrument problem in monetary policy is back on the agenda. Until recently interest rate policy was widely thought to be sufficient for the attainment of appropriate monetary policy goals. No longer. In the wake of the international financial crisis there is much pressure on monetary authorities to incorporate the goal of financial stability more explicitly in policy. This requires an expansion of the instruments typically used by central banks. Cechetti and Kohler (2010) recently considered this new version of the instrument problem in monetary policy by analysing the distinct role and potential for co-ordinating (i) interest rates and (ii) capital adequacy requirements. In this paper we connect this modern debate with an earlier version of the instrument problem, famously discussed by Poole (1970). Then, as now (we claim), the main message of the analysis is the non-equivalence of these instruments and the structural features of the economy on the basis of which one would prefer a particular combination of these instruments. These results are demonstrated with a set of simulations. We also offer a theoretical criticism of the modelling approach used by Cechetti and Kohler (2010).

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File URL: http://www.ekon.sun.ac.za/wpapers/2011/wp042011/wp-04-2011.pdf
File Function: First version, 2011
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Paper provided by Stellenbosch University, Department of Economics in its series Working Papers with number 04/2011.

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Date of creation: 2011
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Handle: RePEc:sza:wpaper:wpapers132

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Keywords: Monetary policy; Instrument problem; Interest rates; Alternative monetary policy instruments; Balance sheet operations; Policy co-ordination;

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  1. Gunnar Bardsen & Kjersti-Gro Lindquist & Dimitrios P.Tsomocos, 2006. "Evaluation of macroeconomic models for financial stability analysis," OFRC Working Papers Series 2006fe01, Oxford Financial Research Centre.
  2. Stan du Plessis & Ben Smit & Federico Sturzenegger, 2007. "Identifying aggregate supply and demand shocks in South Africa," Working Papers 11/2007, Stellenbosch University, Department of Economics.
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Cited by:
  1. Stephen G Cecchetti & Marion Kohler, 2012. "When capital adequacy and interest rate policy are substitutes (and when they are not)," BIS Working Papers 379, Bank for International Settlements.

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