Introduction to Monetary Policy

The key aim of monetary policy for most central banks is to keep inflation low and steady. However in a market-oriented economy, central banks cannot control inflation directly. They have to use instruments such as interest rates, the effects of which on the economy are uncertain. And they have to rely on incomplete information about the economy and its prospects. Some central banks use money growth or the exchange rate as intermediate targets to guide policy decisions. Others take a more eclectic approach and consider a range of factors. Monetary policy has occupied much time of the world’s most distinguished economists over the years. This Handbook provides an introductory overview to the subject. Following the introduction in Section 1, Section 2 describes the main costs of inflation. The next section provides an overview of the various routes by which monetary policy transmits through the economy. And Section 4 describes the alternative targets which central banks can use to guide policy. Some conclusions are provided in Section 5. The purpose of this Handbook is to assist monetary policy practitioners - those in central banks and governments who are advising and taking decisions on monetary policy. Those new to the subject may, it is hoped, find this a useful starting point for further reading and research. This handbook is also available in Russian and Spanish.Monetary, Policy

The impact of yuan revaluation on the Asian region

This paper studies how an appreciation of the yuan affects the exports of other Asian countries. It finds mixed effects. Countries that export consumer goods to China or compete in third markets benefit from yuan appreciation, while countries that supply capital goods to China lose. These findings suggest that a revaluation of the yuan may not lead to a generalised revaluation of Asian currencies.

Resolving banking crises - an analysis of policy options

This paper develops a dynamic model to examine the ex-ante and ex-post implications of five policy options for resolving bank failures when the authorities cannot observe the level of non-performing loans (NPLs) held by individual banks. Under asymmetric information, we show that the first-best outcome is achievable when the authorities can close all banks that fail to raise a minimum level of new capital. But when the authorities cannot close banks and must rely on financial incentives to induce banks to liquidate their NPLs, recapitalisation using equity (Tier 1 capital) would be the second-best policy, whereas recapitalisation using subordinated debt (Tier 2 capital) is suboptimal. If the authorities do not wish to hold an equity stake in a bank, they should subsidise the liquidation of non-performing loans rather than inject subordinated debt. We also show that the cost of this subsidy can be reduced if it is offered in a menu that includes equity injection.

Capital Flows: Causes, Consequences and Policy Responses

Capital inflows have played an important role in promoting growth in many developing and transitional economies. Yet they have also been associated with volatility in variables that central banks use as targets of monetary policy, such as monetary growth, the exchange rate and inflation. This Handbook builds a framework for analysing capital flows, and discusses the circumstances in which different types of flows may have benefits and costs. Many capital flows are a (sometimes rapid) response to changes in the way investors perceive domestic developments in a particular economy. The Handbook argues that identification of the the cause of inflows is very important in determining an appropriate policy response. Such analysis can be performed in the context of a general assessment of how close the economy is to domestic and external equilibrium. Key questions to ask in the face of capital flows are "Is the exchange rate valued appropriately?" "What can be done to offset any excess demand in the economy?" and finally "Is financial instability a cause for concern?". The appropriate policy response depends upon answers to such questions. The Handbook assesses the various policy options available in the context of experience from a wide range of countries. This handbook is also available in Russian and Spanish.Capital Flows, Causes, Consequences, Policy, Responses

Costs of banking system instability: some empirical evidence

This paper assesses the cross-country 'stylised facts' on empirical measures of the losses incurred during periods of banking crises. Firstly, the direct resolution costs to the government are considered, and then the broader costs to the welfare of the economy (proxied by losses in GDP). The cumulative output losses incurred during crisis periods are found to be large, roughly 15%-20% of annual GDP, on average. In contrast to previous research, it is also found that output losses incurred during crises in developed countries are as high, or higher, on average, than those in emerging market economies. Moreover, output losses during crisis periods in developed countries also appear to be significantly larger - 10%-15% - than in neighbouring countries that did not at the time experience severe banking problems. In emerging market economies, by contrast, banking crises appear to be costly only when accompanied by a currency crisis. These results seem robust to allowing for macroeconomic conditions at the outset of crisis - in particular low and declining output growth - that have also contributed to future output losses during episodes.