Central Banks Dissertation

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Central Banks

What criteria are, and have been, used to determine monetary policy. Examine the evidence for and against the view that central banks can control inflation. Should central bank's target zero inflation?

What criteria are, and have been, used to determine monetary policy. Examine the evidence for and against the view that central banks can control inflation. Should central bank's target zero inflation?

Central Banks and Inflation

The Ideal Indicator

An Open Mind

The Consumption Function

Historical and Future Analysis

of the Criteria for Determination

of Monetary Policy

Optimum Currency Area Theory

The Microeconomic Benefits

Reduced Costs of Foreign Exchange Dealings

Chapter Five

Findings and Conclusions

Signature/Approval Page

An Economics Dissertation

Central Banks, Monetary Policy and Zero Inflation


Dr. *** *********, Major Professor

Dr. *** ******, Committee Member

Chapter One

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TOPIC: Dissertation on Central Banks What Criteria Are, and Have Assignment

With fundamental banking problems throughout the world, as revealed by 1997-99 crises, and with the European Union a reality, we ask questions that are no longer just hypothetical. For example: How does one go about structuring and provisioning a new central bank on the basis of analysis, the comparisons of central banks, the facts, the experiments, and the phases of post-World War II developments? Without ignoring the policy matters we associate with the economic analysis, we shall in this thesis, discuss summary statements of interest-rate/fiscal-policy and money-stock regimes and reconsider some hypotheses and institutional concerns. The European Monetary Union (EMU) was an enormous achievement. An overview of it and the related central bank operations go along a twofold route: one, to a sketch of a model central bank for countries emerging with open market economies; and, two, to reflect on central banking and monetary control with respect to the turn-of-the-century Asian economies.

The main central banks introduced in the evolution of central banking are the pre-Blair Bank of England, the post-1930s Federal Reserve, and the pre-EMU Bundesbank. The first is the oldest of the three, as we have said. However, open market operations of a special sort came about at the Federal Reserve Bank of New York and were later written into the Federal Reserve Act. They arise because of key features, namely: the trading desk at the New York Fed may enter the New York market primarily to influence reserves without the requirement that a targeted interest rate is set; and, in the presence of shifts to liquidity, the operations do not require that borrowers take the initiative to expand the money and credit aggregates. The operation may be directed toward inflation-rate targeting and/or controlling money and credit aggregates, even if imprecisely, and irrespective of any interest rate, except as a surrogate for monetary policy (Posen, 2005. pp 254).

The special nature of these New York operations is highlighted by a situation where the short- or long-term bond rate may be quite low -- as in the United States during the 1937-38 recession and in Japan during the 1997-98 Asian crises. In these cases, firms and households do not on the average take the initiative to borrow and accelerate spending. As pointed out by Obstfeld & Rogoff (2006), by contrast, the special open market operations may expand the money stock directly at first and then indirectly by satisfying first the liquidity preference of banks and then that of households. Although these matters require emphasis and go back in the Federal Reserve's history, and although the European Union's European Central Bank (ECB) enters near the century's turn, the pre-EMU Bundesbank is the most recent of the prominent central banks of the twentieth century. Its legacy appears in the new century's European Monetary Union. Early in the move toward a central bank for the EMS member countries, British Labor Party politician Roy Jenkins, German Chancellor Helmut Schmidt, and French President Valery d'Esting were the main players. However, as an early Friedman monetarist, Britain's Margaret Thatcher reacted negatively to the EMS developments. She raised issues over sovereignty and the exchange-rate mechanism, which linked to central bank involvement with fiscal policy prior to Tony Blair's 1997 success with the British Labor Party (Faust, 2006 268-9).

As an early leader in the redirection of the 1970s policies bearing on inflation and efforts at controlling prices by price-control, direct means, Thatcher is a major political figure in the "big U-Turn" (Gerling, et al. 2003). I see this in connection with new ideas contained in the Friedman system of analysis and economic problems such as Thatcher confronted. Also, a focus on the pre-EMU Bundesbank's noninflationary demeanor, its orientation as a central bank, and the notion of ideas impacting policy, draw consideration to Germany, the pervasiveness of changes in the 1980s, and the ideas concerning economic analysis, policy implementation, traditions, and practices. These and other matters of importance to economic analysis accompany the separation-of-effects problem (Sibert, 2003 pp 662) and the symbolic equation. Juxtaposing alternatives found in economic analysis, for the most part, leads to conflicts with what we encounter in the European Community (EC) experience with economic integration. In extending the monetary analysis we ask further why so much attention was given to "one money" or a German/French-led currency block to begin with. The answer centers on transaction costs and exchange-rate uncertainties. Most notably, the substitution of a single currency with a zero inflation rate for multiple currencies with diverse inflation rates and disparate central banking arrangements offered the following prospects (Dixit & Luisa 1999). First, the substitution reduced the direct cost of exchanging one money for another in order to make across the-border purchases. Second, the one money with the attained zero inflation goal reduced the uncertainty associated with holding a given stock of money balances and undertaking long- and short-term contracts concerning the repayment of debt and future deliveries of goods and payments denominated in a currency of uncertain future value. Third, closely allied with reduced uncertainty were reduced costs of getting information about future prospects and legal statuses governing contracts in one vs. another unit of account.

Tying a block of currencies to a single "hard" currency, via an exchange rate mechanism, was a step toward reducing uncertainties and information costs, but this action did not go quite all the way to reducing uncertainty through the acceptance of one monetary medium. Reduced uncertainty over transactions costs and future purchasing power are thought to encourage trade and the indirect exchange of goods through the acceptance of money. However, and more important, the market mechanism with a satisfactory money umbrella disburses power and enhances voluntary association in market, as discussed by Kydland, et al. (1977). The acceptance of the monetary arrangement itself goes back to the definition of money, the speculative shifts in the demand for money, business conditions generally, and the interplay of money as a liquid asset and the real goods markets where we find less liquid assets. Although the following parts of our thesis paper has a special focus (the central banks, the EMS), awareness about money, central banks, and Europe's new place in the global community should be raised by the existence of the European Union. The money and central banking lessons should not be lost on countries seeking to undertake transformations to market economies that call for viable monetary systems.

Central Banks and Inflation

In much of the period 1867-1975, for which Faust analyzed data (Faust, 2006), the world was on a gold or gold-exchange standard. In fact, for most of the nineteenth century and until the early 1930s, with World War I and its immediate aftermath aside, the neighborhood in and about London was on a gold or gold-exchange standard that gains its significance in relation to the gold-flows mechanism. Under the classical form of the gold standard three rules held: (1) there is free coinage of gold; (2) the price of gold is fixed by law in terms of a country's monetary unit (e.g., the dollar in the United States and the pound in the United Kingdom), and hence there are fixed relations between the units of account (e.g., $/£ const.) for the most part; and (3) paper currency, coins, and bank deposits are freely convertible into gold under a gold-exchange standard. It comes about where some currency, such as the British pound in its day, is accepted by other central banks as a key currency and hence as good as gold.

Quite briefly, under the gold standard, countries trade goods and services and compete for sales in domestic and foreign markets where attention is focused on prices. The matter is viewable as if the respective countries have averages for their prices (or price indexes). As one country's relative position is favored for trade purposes [say, -? (P U.S. / P UK ) for a favored U.S. position], that country exports more and enjoy an inflow of monetary reserves (the symbol G. In the bank reserve equation), as a rule. There is a balancing out of reserves as the countries compete in terms of trade in goods and services. The main point, however, is that the competition regulates price averages and disperses power that may… [END OF PREVIEW] . . . READ MORE

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