2.3 MONETARY POLICY STRATEGIES
Having identified the instruments available for active
monetary policy implementation, it is important to understand the current
conduct of monetary policy. The latter needs to be operated within a
well-defined independent Central Bank.This means simply to provide the
authorities of Central Banks with the power to determine quantities and
interest rates on its own transactions without interference from government
institutions (Lybeck, 1998 quoted in Worrel, 2000). Similarly, Blinder (1998)
shows that Central Bank independence means two things: Firstly, that the
Central Bank has the freedom to decide how to pursue its goals, and secondly,
that its decisions are very difficult for other branches of government to
reverse. This implies that an independent Central Bank needs to be free of the
political pressures that influence other government institutions. This is
particularly important when a Central Bank needs to target inflation, exchange
rates or the monetary base for example. On this basis, an important point to
analyse could be the way Central Banks process before following a given
strategy.
2.3.1 Choosing and Using a Target
As is already known, in conducting monetary policy, Central
Banks have the responsibility to achieve certain goals or final objectives. The
latter could be the inflation rate, the GDP and others. According to Mishkin
(1997) the strategy can be explained as follows: «after deciding on its
goals, the Central Bank chooses a set of variables to aim for called
intermediate targets such as monetary aggregates, interest rates etc. which
have a direct effect of the goals. The Central Bank's policy tools do not
directly affect these intermediate targets. Alongside this, the Central Bank
chooses another set of variables to aim for, called operating targets or
instruments among others reserve aggregates or interest rates which are more
responsive to its policy tools» (Mishkin, 1997: 478) In more general
terms, Mishkin argued that the main reason for trying to achieve its goal by
using intermediate and operating target, is simply to allow the Central Bank to
judge whether its policies are on the right path and to make mid-course
corrections, rather than waiting to see the final outcome of its policies.
The process starts from Central Bank policy tools and directly
affects the operating targets, which in their turn affect the intermediate
targets, and finally the latter affect the goals. As has been specified above,
the intermediate targets comprise monetary aggregates and interest rates. In
practice three criteria are suggested for choosing one target between them. The
three criteria can be summarised briefly as follows:
- Measurability: quick and accurate measurement of an
intermediate target variable is necessary because the intermediate will be
useful only if it signals when policy is off track more rapidly than the
goal.
- Controllability: The good intermediate target is the one on
which the Central Bank must be able to exercise an effective control.
- Predictable effect on goals: the goals must have a close
link with intermediate target chosen. (Mishkin, 1997:482).
The same criteria remain valid about choosing the operating
targets. A preferable operating target must have a more predictable impact on
the most desirable intermediate target.
The strategy described above is not, of course the only one
that allows a well conducted of monetary policy. In addition, Central Banks
have increasingly sought to reach their objective of macroeconomic stability
through the adoption of certain principles known as rules for monetary policy.
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