Project African Monetary Reform (PAMR)

Project African Monetary Reform (PAMR) – post 1

The blogoshere is full of debates about US monetary policy and the mistakes of the ECB are also hotly debated. However, other than that there is really not much debate in the blogoshere about monetary policy issues in other countries. I have from I started blogging said that I wanted to broaden the monetary debate and make it less US-centric. Unfortunately I must say I also tend to write a lot about US monetary policy and there is no doubt that most of my readers are primarily interested in US monetary affairs. However, I still want to have a broader perspective on monetary theory, policy and history. Therefore as of today I am launching Project African Monetary Reform (PAMR).

I have no clue where PAMR will lead me other than I have a large interest in the African continent and it’s economies so why not combine it with my interest in monetary policy? My regular readers will know that I already have produced a number of posts related to African monetary issues. PAMR as such will not be a major change and I will not promise any regularity in my posts in the PAMR “series”, but I hope PAMR can be a framework within which I can write a bit more on African monetary matters. I will not get into the business of forecasting central bank behavior and market movements (I spend time on that kind of thing in my day-job), but I will hope to contribute to the discussion about monetary reform in Africa. Something still badly needed in many African countries.

In the process of studying monetary reform issues in Africa – we might even learn some good lessons for more “developed” economies like the US and the euro zone. So even if you are not interested in what is going on in Africa you might learn from tracking PAMR.

I therefore also would like to invite other economists, academics and policy makers with interest in African monetary reform to get in contact with me so we might be able to build a network of people with such interests. Furthermore, I would as always welcome guest posts concerning African monetary issues from other economists with special knowledge or interest in African monetary reform. I can be contacted at lacsen@gmail.com

Furthermore, I will invite you my dear readers to give me suggestions for the next post in the PAMR series. I want to take a look at the monetary policy set-up in a “random” African country. You my dear readers will make the choice on what country I should start with. But I rule out writing something on the three large ones: South Africa, Nigeria and Egypt. You can write the suggestion here or drop me a mail. I am all hears.

Some of my previous posts related to African monetary issues:

The spike in Kenyan inflation and why it might offer a (partial) solution to the euro crisis

“Good E-money” can solve Zimbabwe’s ‘coin problem’

M-pesa – Free Banking in Africa?

 

Imagine that a S&P500 future was the Fed’s key policy tool

Here is Yale economics professor Stephen Roach:

“The ECB is pretty much out of ammunition.”

This sentence probably best illustrates what is wrong with monetary policy thinking in today’s world. Obviously the ECB is not out of ammunition, but Roach’s perception is very common.

What Roach fails to realise is that when central banks announce what we in general terms could call the “key policy rate” it is really just announcing a intermediate target for a given market interest rate. What the central bank actually is doing it setting the money base to fix a given market interest rate at a given level. In that sense the interest rates is merely a tool for communication. Nothing else.

The problem is that in most standard macroeconomic models the central bank does not determine the money base – in fact there is no money in most of today’s mainstream macroeconomic models – but rather the “interest rate”. In a world where interest rates are well above zero that is not a major problem, but when the key policy rate gets close to zero you get a communication problem. However, this is really only a perceived problem rather than an actual problem. The central bank can always expand the money base – also if the key policy rate is zero or close to zero.

The mental problem really is that interest rates have replaced money in today’s mainstream (mostly New Keynesian) macroeconomic models. Lets therefore imagine that we constructed a simple macroeconomic model where there is no interest rate, but where the central bank’s communication tool is stock prices or rather stock futures.

Many economists would willingly accept that stock prices can influence both private consumption (through a wealth effect) and investments (through a funding cost effect) and as such that would not be different from the “normal” assumption about how interest rates influence domestic demand. Therefore, by influencing the stock prices the central bank would be able to influence domestic demand. Note of course that I on purpose am “keynesian” in my rhetoric just to make my point in regard to mainstreaming thinking of monetary policy. (Obviously stock prices as well and private consumption and investments are determined by expectations of future nominal income.)

Then now imagine that the central bank every month announces a certain level for the a stock market future instead of announcing a key policy interest rate. So for example in the case of the Federal Reserve the FOMC would every month announce a “target” for a given S&P500 future.

Would anybody question that the Fed could do this? And would anybody question whether the Fed could hit that target? No, of course not. The ECB obviously could do the exact same thing. There would be absolutely no technical problem in using stock prices (or rather stock futures) as a policy instrument.

Do you think Stephen Roach would argue that the ECB “pretty much” was out of ammunition had just increased it’s target for the Euronext 24 month future with 5%? No of course not and that in my view clearly illustrates that the zero bound on interest rates only is a mental problem, but an actual problem.

Finally note that I am not advocating that central banks should target stock prices (I advocate they should target an NGDP future), but I see little difference in such a policy instrument and interest rate targeting. Furthermore, there would not be a zero bound problem if the Fed was targeting S&P500 futures rather than interest rates and Stephen Roach might even realise that the ECB in no way is out of ammunition.

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PS over the long run NGDP and stock prices are actually quite strongly correlated and hence if the Fed announced that S&P500 should increase by lets say 5% a year over the coming 5 years and that it would ensure that by buying (or selling) S&P futures then it would probably do a much better job at hitting a given level of NGDP or inflation for that matter than the Fed’s present weird policy of promising to keep interest rates low for longer or the silly operation twist.

PPS I am pretty sure that Stephen Roach full well knows that the ECB is not out of ammunition, but when you talk to journalists you might make some intellectual short-cuts that distorts what you really think. At least I hope that is what happened.

PPPS If the Fed wanted to target the NGDP level then it is pretty easy to construct indicator for future NGDP from S&P500 futures, TIPS inflation expectations, CRB futures and the nominal effective dollar rate and then the Fed could just use that as a communication tool. Then it would never ever again have to talk about QE or running out of ammunition.

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Update: When I started writing my post I was thinking that Nick Rowe might have  written something similar. And yes, indeed he actually wrote a number of posts on the topic. So take a look at Nick’s posts:

“The Bank of Canada should peg the TSE 300” – revisited
Why the Bank of Canada should ‘rise’ interest rates
The Fed should buy pro-cyclical assets, not bonds

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