"The monetary policy framework of the ECB"

In this short presentation I cannot discuss the concrete definition of the ECB’s final target which is an increase of the harmonised index of consumer prices in the euro area of "below 2 percent". Thus, I will focus on the monetary policy framework that the ECB has developed in order to achieve its target

THE SCOPE FOR FOREIGN EXCHANGE MARKET INTERVENTIONS

The discussion on exchange rate policy is dominated by the so-called “impossible trinity”. According to this principle an autonomous monetary policy, a control over the exchange rate and free capital movements cannot be achieved simultaneously. In this paper, a strategy of managed floating is developed that allows transforming the “impossible trinity” into a “possible trinity”. If a central bank targets an exchange rate path which is determined by uncovered interest parity (UIP), it can at the same time set its policy rate autonomously. As a UIP path removes the incentives for carry-trade, it is also compatible with capital mobility. The approach can be used unilaterally to prevent carry trade as a central bank can always prevent an appreciation of its currency. But it can also be applied bilaterally or multilaterally. Successful examples are the European Monetary System and the exchange rate policy of Slovenia before its EMU membership.

The EMU after Three Years: Lessons and Challenges

The paper provides an analysis of the first three years of the European Monetary Union. It discusses the changeover to Euro notes, the performance of monetary policy in terms of price stability and real growth, the establishment of credibility for the ECB, and the two pillar strategy. The weakness of the euro's exchange value during the first three years is explained. Some aspects of the eastern enlargement of the eurozone are examined especially the problems that may be associated with the lack of real convergence. Other issues such as the importance of a Balassa-Samuelson effect and the need for appropriate fiscal policies are discussed.European Monetary Union, European Central Bank, Euro, monetary policy

The German monetary unification (Gmu): converting marks to d-marks

Monetary policy - Germany ; Germany

The Stability and Growth Pact Time to Rebuild!

Within this paper we specify a symmetric two country model for the euro area to evaluate monetary and fiscal policy interaction with decentralized fiscal authorities. Obviously this calls for rules which neatly balance the chances and perils. Thereby we show that stringent rules are a prequisitive for a harmonious functioning of a monetary union. Nevertheless given the ability of fiscal policy to effectively stabilize the economic cycle we show that the current rules in reign are of little use. We close the paper by making some suggestions along which the Stability and Growth Pact might be reformed. --Economic and Monetary Union,Fiscal Policy,Fiscal Rules,Stability and Growth Pact

Options for the exchange rate policies in the EU accession countries (and other emerging market economies)

We develop an institutional framework for central banks that try to pursue a stability-oriented monetary policy with the strategy of exchange rate targeting. Recent experience shows that a crucial element of this approach is to avoid destabilising capital inflows. Policy makers can exert monetary pressure by two different but interrelated channels: the interest rate and the exchange rate. We introduce an open-economy Taylor rule which determines the domestic interest rate of a central bank targeting a depreciation of its exchange rate. The interrelation of the two channels is taken into account by a risk premium adjusted uncovered interest parity condition. In our view sustained violations of this constraint provide an important explanation for the problem of speculative capital inflows. We distinguish between two basically different types of pegs: fixed nominal exchange rate targets and flexible nominal exchange rate targets. With the lessons that we draw from the past experiences of these regimes in Asia, Latin America, Eastern and Central Europe and the ERM I, we develop a framework for the exchange rate strategies of the accession countries during their path towards EMU entry. --EU accession countries,monetary integration,emerging market economies,flexible nominal exchange rate target,open-economy Taylor rule,UIP,risk premium,monetary conditions index,capital flows

Managed floating: Understanding the new international monetary order

Although there seems to be a broad consensus among economists that purely floating or completely fixed exchange rates (the so-called corner solutions) are the only viable alternatives of exchange rate management, many countries do not behave according to this paradigm and adopt a strategy within the broad spectrum of exchange rate regimes that is limited by the two corner solutions. These intermediate regimes are characterized by significant foreign exchange market interventions of central banks and a certain degree of exchange rate flexibility. We develop a new empirical methodology that identifies three different forms of floating on the basis of a central bank's intervention activity: pure floating (no interventions), independent floating (exchange rate smoothing), and managed floating (exchange rate targeting). Our cross-country study shows that exchange rate targeting is at least as important as exchange rate smoothing. Subsequently we present a monetary policy framework in which central banks use the exchange rate as an operating target of monetary policy. We explain the mechanics of interventions and sterilization and we explain why a central bank has an interest of controlling simultaneously the exchange rate and the short-term interest rate. We derive the monetary policy rules for our two operating targets from a simple open economy macro model in which the uncovered interest parity condition and the Monetary Conditions Index play a central role. --exchange rate regime,monetary policy,interventions,sterilization,floating,Monetary Conditions Index

Should one rely on professional exchange rate forecasts: An empirical analysis of professional forecasts for the /US-$ rate

The study analyses the characteristics of professional exchange rate forecasts for the /US-$ rate. The results indicate that the quality of forecasts produced by profes-sional economists is rather poor and incompatible with the rational expectations hy-pothesis. This dismal result is according to our analysis attributed to the fact that professional forecasts are to a large extend influenced by actual changes in exchange rates. A reasonable explanation for this behaviour can be derived from the behav-ioural finance literature. According to the anchoring heuristic decision processes are often dominated by available pieces of information even if they are obviously of no relevance. --foreign exchange market,rational expectations,forecasts,behavioural finance,anchoring heuristics

The Svensson versus McCallum and Nelson Controversy Revisited in the BMW Framework

This note shows that the Svensson versus McCallum and Nelson controversy battled in the Federal Reserve Bank of St. Louis Review (September/ October 2005) can be mapped into a static version of a New Keynesian macro model that consists of an IS-equation, a Phillips curve and an inflation targeting central bank (e.g., Bofinger, Mayer, Wollmershäuser, (2006); Walsh (2002)). As a contribution to literature we supplement the controversy by a forceful graphical analysis. The general debate centers on the question by which notion monetary policy should be implemented. The two sides have fundametaly opposite views on this issue. Svensson argues for targeting rules as a notion of optimal monetary policy, whereas McCallum and Nelson promote simple instrument rules. In this note we systematically analyze these two categories of monetary policy rules. In particular we show that the rule discussed by McCallum and Nelson (2005) imposes different degrees of variability on the economy compared to a targeting rule when monetary policy falls prey to measurement error. To our opinion the rule developed by McCallum and Nelson contradicts the original idea of simple rules as a heuristic for monetary policy making and should be rebutted for practical reasons . --inflation targeting,monetary policy rules,New Keynesian macroeconomics,central bank strategies

Monetary and fiscal policy interaction in the Euro area with different assumptions on the Phillips curve

In this paper we carry over a static version of a New Keynesian Macro Model developed in previous papers (see Bofinger, Mayer, and Wollmershäuser 2002) to a monetary union. For a similar approach see (Uhlig 2002). We will show in particular that a harmonious functioning of a monetary union critically depends on the correlation of shocks that hit the currency area. Additionally a high degree of integration in product markets is advantageous for the ECB as it prevents that national real interest rates can drive a wedge between macroeconomic outcomes across member states. In particular small countries are in a vulnerable position exposed to asymmetric shocks and therefore in need for fiscal policy as an independent stabilization agent with room to breath. --Monetary policy,inflation targeting,fiscal policy,policy coordination,free-riding