News Horizons: Monetary Policy in the Developed World

An article from the Economist, “Brave New Worlds”, explores the strategic horizons of rich-world central banks as they turn to more “doveish” policy stances. The article explains that after four years of trying to reinvigorate economies, the central banks of America, Britain and Japan are “experimenting with a shift in approach – coupling monetary action with commitments designed to alter the public’s expectations of interest rates, inflation and the economy”. This sense of change, says the article, is reinforced particularly by the promise of new political leadership in Japan. Likewise, the article also discusses challenges facing the Bank of England and the Federal Reserve in the crosshairs of upholding mandates to maintain low inflation and high employment. It may be an era that witnesses higher inflation rates, according to the article

 In particular, I think much of what we have discusses in class can be viewed through the lens of Japan. An another article from the Economist, “Win Some, Lose Some”, takes a look at the monetary policy debate specifically Japan, an issue over which the prime minister and the central bank are butting heads. Shinzo Abe, the new prime minister, has declared to curb the independence of the Bank of Japan in order to “strong-arm” the country out of its entrenched deflation and spiraling debt. The move would sacrifice monetary autonomy, but potentially reflate the Japanese economy.

Like we have discussed in class, there is a “trilemma” that lies in the balance of fixed exchange rates, free capital flows and sovereign monetary policy. A country can fix its exchange rate without weakening its central bank, but only by maintaining control of capital flows. It can leave capital flows free and retain monetary autonomy, but let exchange rates fluctuate. Or it leave capital free and stabilize the currency through fixed exchange rates, but only by relinquishing monetary autonomy.  Referencing comments made by Krugman, the article describes Japan’s situation as a “looking-glass realm in which virtue is vice and prudence is folly”, that is, perhaps the government is onto something by letting interest rates and inflation run their course.

However, as the article points out, the Bank of Japan is refusing to relinquish its sovereignty without a fight, expressing misgivings about its ability to meet the expectations of Abe’s regime change” in economic policy. It set a 2% inflation target and agreed to open-ended asset purchases, but time frame appears to be a vision on broad horizons rather than a tactical plan. The Bank of Japan has also attempted to mediate another part of Abe’s economic policy – fiscal stimulus. The article explains, “Monetary easing alone does not boost GDP much if the private sector cannot be persuaded to borrow, so the government provides the missing demand via stimulus”. The central bank’s asset purchases are meant to ensure financing will be available for the stimulus. Altogether, the Bank of Japan has not yet taken the reforms in stride, weakening Abe’s leverage on monetary policy.

           

In addition, there is talk of deregulation and new trade agreements. Another big idea floating on the table is using the bank to buy government bonds. However, the most controversial ideas may have to wait on the back burner until an upper-house election in July. But many feel that the country cannot “afford to linger”. Altogether, this also brings into account the importance of institutions in determining how governments make monetary policy decisions.  For an interesting article on that front, check out “The Voice of Public Choice”. In a testament to the late economist, James Buchanan, the article analyzes an era of fiscal deficit and growing debt from misguided monetary policy in the United States.