Central bank power is a matter of faith
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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|Date of creation:||04 Mar 2005|
|Publication status:||Published in The ICFAI Journal of Monetary Economics, 2005, pages 70-84.|
|Contact details of provider:|| 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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References listed on IDEAS
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- 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.
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- 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 321-338, November. Full references (including those not matched with items on IDEAS)
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