CURTIN UNIVERSITY OF TECHNOLOGY
PERTH :: AUSTRALIA
SCHOOL OF ECONOMICS AND FINANCE
Unit: Economics 564
Course Controller: Sandra Hopkins
SEMINAR
Central Bank and Monetary Policy
Presented on 1.9.92
By
Li Guan Huang
Stan Lakocy
Sanjeev Sabhlok
CENTRAL BANK AND MONETARY POLICY
Theme:
There are two broad views of the role of central bank
in the operation of monetary policy.
i)
The first is based on the normative issue of the
central
bank's
role
in
improving
economic
welfare.
ii)
The second approach is the positive one, where
the central bank sets or has set for it rules for
the behaviour of observable variables.
Discuss
the relationship between
alternative views of the
policy by the central bank
operation of monetary
and alternative views of monetary theory.
Apply your discussion
to the current debate in Australia on the role of the
central bank in the operation of monetary policy.
STRUCTURE OF THE PRESENTATION:
We shall structure the presentation as follows:
1.
Alternative Views of Monetary Policy: by Stan Lakocy
2.
Role of Central Bank and constraints faced by it in
framing its policies: by Sanjeev Sabhlok
3.
Deregulation and the current debate on the role of the
Reserve Bank of Australia in the operation of monetary
policy: by Li Guan Huang
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PART I
ALTERNATIVE VIEWS OF MONETARY POLICY
===========================================================
1.1. The monetarist view:
Monetarists claim that a government can influence only
a limited number of global macroeconomic variables, such as
money supply growth, government expenditure, taxes, and/or
a government deficit. So they suggest applying fixed rules
for the behaviour of these variables. They claim that the
money supply should grow at a certain fixed percentage rate
per year, both in conditions of recession and in boom, and
that a government budget should be balanced, on the
average, over a period of four to five years.
Some of them also think that introduction of a
constitutional amendment requiring a government to balance
its budget and limiting a fraction of people's incomes
which a government can take in taxes is necessary. If any
policy interventions occur they always should be announced
as far ahead as possible to enable people to take them into
account while planning and ordering their own economic
matters.
1.2. Keynesian view:
Keynesian (non-monetarist) economists favour active
intervention arguing that if new information arises, it
would be foolish not to use it.
Thus they claim that an
intervention to `fine tune' an economy is necessary to
bring it to full-employment and low inflation.
If
necessary, they advise direct control of inflation by
controlling
prices
and
incomes
as
well
control
of
unemployment by stimulating aggregate demand while using
both monetary and fiscal policies.
In a depression they claim it is necessary to exercise
some kind of a discretion in seeking to stimulate an
economy. Conversly, during a boom it is advisable to hold
it back somehow. So according to them there is a need to
modify the policy applied depending on the current
situation and policy changes are best not pre-announced in
order to deter speculation.
As far as monetary policy is concerned their advice is
either to raise money supply to a higher level than it
otherwise would have been if output is (or is forecast to
be) below its full-employment level, or to lower money
supply below what it otherwise would have been if output is
(or is forecast to be) above its full-employment level.
1.3. Comparison of monetarist and Keynesian theories when
shocks affect economy:
1.3.1 Demand shocks
According to the theory of aggregate demand, holding a
money supply and fiscal policy variables constant, the
position of the aggregate demand curve will be fixed as
well as fully predictable only if a consumption function,
investment function, demand for money function and the
international flows of goods and capital are fixed and
fully predictable.
However, many factors exist that can
cause individuals to vary, over time, their consumption,
investment,
demand
for
money
and
international
transactions. Although on average such factors cancel out,
for most of the time, when aggregated over all individuals
in an economy, sometimes these factors can be important and
are
actually
in
a
position
to
knock
an
economy
significantly away from its normal equilibrium position.
If aggregate demand shocks occur they will cause a shift
of an aggregate demand function (either up or down) as
presented on Figure 1. and if monetarist policy is applied
there are no unanticipated changes in a money supply so
that will cause income and price levels to change (increase
or derease).
As a result an economy will be forced to
experience random deviations of output from its fullemployment level as well as random deviations of a price
level from its expected position.
If in the preceding case the Keynesian policy is
utilized and there is a positive random shock to an
aggregate demand shifting the aggregate demand curve to the
higher position (see AD(Mo)+e1 Figure 2 advice is to cut a
money supply.
And if the money supply is cut by exactly
correct amount, it will be possible to offset the positive
aggregate demand shock, thus making the actual aggregate
demand curve the same as the curve AD(Mo).
Folowing that
Keynesian policy rule of changing the money supply to
offset the aggregate deamand shock gives the prediction
that output will stay constant at y* and the price level
will stay at its rational expectation level Po.
The same
conclusion arises if the consequencies of a negative
aggregate shock are examined.
As can be seen consequencies of following Keynesian
stabilisation policy are to remove all the flactuations
from output and to keep the price level at its rationally
expected level.
The essence of different views between Keynesian and
monetarists regarding effects of monetary policy comes to
the question of information and ability to utilize new
information.
Monetarists claim that the bank has no
informational advantage over private agents and that it can
actually do nothing that private agents cannot do for
themselves.
Thus any attempt by the bank to fine tune or
stabilise the economy by adjusting money supply to previous
shocks, known to every one will not make output behave
better than it otherwise would have done. So, actually it
will only make the price level more viable.
Contrary to the monetarist view Keynesians claim that there
is an informational advantage, quite effective, to the
bank.
Although they agree that people form their
expectations rationally utilizing all the information
available, they assert that individuals get locked into
contracts based on expected price level, which, after the
aggregate demand shock, proves to be wrong.
In such a
situation the bank can act to compensate for and offset
effects of these random shocks, while private agents
actually locked themselves into contracts based on the
wrong price level expectation. So, if the bank can change
the money supply quickly enough the Keynesian policy
result, as discussed previously, can be achieved. Thus the
essence of debate regards the flexibility of private sector
responses compared to the flexibility of bank's responses
to random shocks affecting the economy.
In view of he
aforesaid if every individual can react quickly and
effortlessly like anybody else there is no advantage
resulting from following Keynesian policy and even there
are disadvantages due to the more variable price level.
However, if the bank can act quicker than the private
sector, there might be a gain in the form of a reduced
variability of output and the price level while following
principles of the Keynesian view.
The question of deciding which of those two theories better
describes the real world is unsettled so far.
1.3.2. Supply shocks
If supply shocks hit the economy and the monetarist
theory is applied there is a shift of the aggregate supply
curve which is not offset by any monetary action and thus
the economy settles at different point (B) with a price
level of P1 and oputput y1 (see Figure 3). If, during the
next period such shock disappears and the economy returns
to its normal position on the aggregate supply curve ASo
with the expectations-augmented aggregate supply curve EASo
the economy comes back to the full employment point A, from
which it started. So, following this policy results in
movements in output and the price level in opposite
directions to each other, thus creating stagflation (the
economy stagnates and inflates at the same time).
If in the same situation the Keynesian theory is
followed the money supply will be stimulated thus raising
the aggregate demand curve to the AD(M1) curve and the new
equilibrium point will be C, with output at y* as
originally, but with the price level at P1. (see Fig.4).
During the next period when the aggregate supply shock
disappears and the economy returns to its normal aggregate
supply curve ASo, one of four possibilities will occur.
First, if the money supply returns to its original level Mo
and if everybody anticipates that to arise the economy will
return to its original position A.
Second, if the money
supply is maintained at that higher level M1 and everyone
expects that this will occur the economy will stay at the
point C, but the expectation-augmented aggregate supply
curve EASo will turn to EAS1, while being the expectationaugmented aggregate supply curve drawn for the value of the
money stock equal to M1 and with the aggregate supply curve
at ASo. Third and fourth if there is a confusion in minds
of economic agents as if the monetary authorities will
return to the original money supply or stay with the new
money supply then the expectations-augmented aggregate
supply curve will be located somewhere in between positions
A and C on the ASo curve and the economy will experience an
output boom if the money supply stays at M1, or an output
drop if the money supply returns to Mo. Which of the obove
four possibilities will actually occur depends on the
monetary policy followed by the Reserve Bank.
If in the
past it responded to supply shocks with a one-period
loosening of monetary policy and a reverting back to the
original level of the money supply after that, then the
first possibility will arise.
If the bank exercised
expanding the money stock earlier, to response to a supply
shock and then maintaining the money supply at its new
level, then the second possibility will happen while the
third and fourth ones will only occur if the bank has
generated confusion in minds of economic agents resulting
from its own earlier random behaviour.
Thus, following the Keynesian policy in case of
aggregate supply shocks results in inflation at the
beginning but with no drop in output and employment,
contrary to the monetarist policy.
Then, during the next
period, whether inflation falls and/or output falls, rises
or stays at its full-employment level depends on what the
expected and actual money supplies are.
The Keynesian policy allows to avoid changes in
employment and output, but it is difficult to implement
since a lot of information is needed regarding magnitude of
both aggregate demand and aggregate shocks.
Also if both
types of these shocks occur in the same time, it is
necessary for policymakers to be in a position to
disentangle the separate shocks and offset both of them in
a proper way and with a greater speed than the private
sector can react in response to them.
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PART II
ROLE OF CENTRAL BANK AND CONSTRAINTS FACED BY IT
IN FRAMING ITS POLICIES
===========================================================
2.1
Background:
According to Will Rogers the invention of the concept
of central bank is one of the three great inventions in the
history of mankind, the other two being fire and the wheel
(Vaish:456). The central bank is a relatively recent
concept. A few central banks were established over two
hundred years ago, the first of these being the Bank of
England. But out of the over 140 central banks worldwide in
1980, more than half were established after 1940. In fact
the USA also established its Central Bank (the Federal
Reserve) only in 1913.
Central banks are not "banks" in the conventional
sense, they are institutions concerned with managing the
money stock, preventing financial panics by acting as
lenders of last resort, and other government tasks.
Central banks perform services, such as holding reserves
and clearing checks for banks, and also act as the
government's bank, doing such chores as issuing currency.
Central banks can create reserves for the banking system.
2.2
Functions of the Central Bank:
A Central Bank has an assortment of functions. We list
below some of the more important of these:
1.
Bank of issue
issue.
-
it possesses the monopoly of note
2.
Banker, agent and financial adviser to government financing short-term requirements of the government.
3.
The Central Bank assists in the formulation of credit,
monetary, exchange rate and banking policies of the
government.
4.
Regulator of the monetary and banking system. For this
purpose it has powers of supervision over commercial
banks. (Juttner:45) This also includes the function of
lender of last resort.
5.
Banker to trading and savings banks and authorised
money market dealers, etc. (Juttner:45) Thus it is
also the bank of central
settlement and transfer
acting as a clearing house.
6.
Custodian of nation's foreign exchange reserves.
We shall concern ourselves with the function No.3
above - i.e., the formulation of credit, monetary, exchange
rate and banking policies of the government.
2.3
Operational role of Central Banks in Monetary Policy:
The development of economic theory, and particularly
the monetary theory, has a great role to play in the
operating procedures of the Central Bank. For our purposes
here we accept the definition of monetary policy given by
Harry G. Johnson (Vaish:411), i.e., monetary policy is a
"policy employing the central bank's control of the supply
of money as an instrument for achieving the objectives of
general economic policy." Therefore the monetary policy of
a country and the role of the central bank are interlinked
very closely.
The role of the Central Bank has broadly undergone the
following stages, co-terminus with the evolution of
monetary theory, which was discussed in Part I.
2.3.1
Pre-Keynesian:
Upto
1936,
monetary
policy
generally
aimed
at
maintaining
fixed
exchange
rates
against
the
currencies of other "gold standard"
countries. Thus
monetary policy served as a means of protecting the
nation's gold reserves. The Quantity Theory of Money
was the model for these operations.
The central banks during this period focused upon the
reserve ratios as affected by gold flows and took
steps to correct fluctuations in the gold reserves.
2.3.2
Emasculation of Monetary Policy: 1936-mid 1950s
The influence of Keynes made governments spend more
and tax less (fiscal policies) and reduced the role of
central banks considerably. The view was that monetary
policy could not influence interest rates which would
not fall below some positive level due to the
liquidity trap. Thus money did not matter in the
1940s. This approach was modified and expanded by neoKeynesians in the 1960s, who identified the use of
interests rates as the main instrument of monetary
policy (Dowd:172).
During this period the central banks had practically
no role in major economic policy matters.
2.3.3
Comeback of Monetary Policy (1956)
In 1956, Milton Friedman of the Chicago School
published essays which showed that money did matter,
after all.
According to Milton Friedman (Auerback:681), the
central banks can only exercise direct control over
the monetary base, and it is with the supply of money
that they should concern themselves. He was against a
discretionary monetary policy.
This view was debated for long and ultimately led to a
positive role being played by central banks in
determining monetary policy. Money targetting became a
trend across the world since the mid-1970s, but it was
quickly given up, since nowhere could a central bank
achieve its announced targets.
2.3.4
The controversial "demise" of the monetarists:
Since the late 1980s, the monetarists have suffered a
serious decline, since it was found that monetary
policy, as implemented in the USA, Britain, etc., was
not capable of achieving rigid control on the monetary
variables. Senator Robert C. Byrd (Auerbach:637) said
in 1982,"Stripped of all technical jargon, monetarists
believe that the only way to stop inflation is to
start a recession."
This so-called demise of the monetarists has been very
controversial, since many monetarists still feel that
their policies were not properly implemented.
However, monetarism has not totally died out. Rigid
adherence to money supply control has been substituted
by
a
set
of
fundamental
economic
variables
(checklisting approach).
2.4 Current
policy:
role
of
Central
Bank
in
framing
monetary
The Central Bank operates through a set of objectives,
also called the ultimate targets. (Auerbach:654) These
include things like output, employment, inflation and
foreign exchange rates. In the case of Australia, the RBA
has the ultimate target to ensure "that the monetary and
banking policy of the Bank is directed to the greatest
advantage of the people of Australia (in such a manner that
it) will best contribute to the stability of the currency
of Australia, the maintenance of full employment in
Australia, and the economic prosperity and welfare of the
people of Australia ." (Juttner: 46)
Very often, as in the case of Australia today,
"legislation
obliges the RBA's Board to pursue objectives
that are not simultaneously attainable." (Juttner:48)
From these ultimate targets the intermediate targets
are derived. These could be things like monetary and credit
aggregates, and interest rates (Mayer:66).
In fixing the intermediate targets, three factors play
a role:
a.
Economic theory: At this point the relationship with
alternative views of monetary policy is taken into
account.
b.
Political
influence:
Central
Banks
of
different
countries differ to the extent in which they determine
the ultimate and intermediate targets. Some banks
exercise greater independence and have a greater role
in the determining of these targets. Others have a
limited role and the government plays the dominant
role. The trend in the world appears to be to allow
greater independence to Central Banks. (Juttner:48)
c.
Bureaucracy
of
the
Central
Bank:
(Mayer:242).
According to this hypothesis, the central bank
officials behave in a way which will avoid regret
(regret-avoidance theory) and criticism, and at the
same time wish to enhance their power and self-image.
It is sometimes alleged that Central Banks desire such
a "monetary mystique" since it allows them to explain
away almost any set of monetary variables in the
economy, and reduces their accountability.
Mayer's book analyses the Fed's motivation (the
Central Bank of the USA), by "paying attention to the
political and bureaucratic context in which monetary
policy is made." (Mayer:1990a:3)
Thus, "in general, the objectives of monetary policy
can be seen as being subject to continual agitation by a
wide range of political interests that vent themselves
through
the
process
of
collective
decisionmaking"(Dowd:170)
Ultimately, the intermediate targets lead to a set of
operating instruments, which are used to affect the
behavioural variables of the economy on a day-to-day basis.
These include the bank rate, open market operations, direct
intervention in the markets including moral suation, and
the fixation of reserves.
2.5
Note on Selection of objectives by Central Banks:
The dilemma of the central bank is how to select its
objectives.
"The selection of different
ultimate targets is
not easy, as some ultimate targets are sometimes
inconsistent with one another. In addition, the
specification of what is meant and whether the
target should be achieved in the long run or the
short
run
are
often
not
made
clear."
(Auerbach:672)
It is important to realise at this stage that any
effort to impose models of the behaviour of Central Banks
are liable to be incomplete depictions of reality.
"There is now a tradition in economics of
treating practical problems in the following way:
Those components that can be analysed rigorously,
perhaps
by
formulating
them
as
game-theory
problems, are given painstaking and rigorous
attention, but other components are more or less
dismissed by arm-waving. The result is, as
Herbert Stein has put it, `on many questions of
economic policy there is no bridge between theory
and decision.'" (Mayer:1990a:3)
The paper entitled "Central Bank Behaviour and
Credibility: Some Recent Theoretical Developments" by Alex
Cukierman (Wilcox:270), which we shall now have a look at,
must be seen in this context.
2.6 Central Bank and Credibility:- Models
Game theory methodology:
The game theory methodology has been applied to the
analysis of the motives, constraints and information of
policymakers
and
the
public
which
are
presumed
to
determine monetary policy outcomes. Various models have
been developed, such as Kydland and Prescott (1977), Barro
and Gordon (1983), Backus and Driffill (1985), Vickers
(1986), etc. (Bandyopadhyay:252), but none seems to have as
yet arrived at something which can be analysed by real
data.
In
these
models
various
issues
such
as
time
inconsistency of policies, etc., arise. Some models show
that optimal policies formulated by minimising some welfare
function become, with the passage of time, sub-optimal.
Most of these models assume that much of inflation is
generated by persistent increases in the monetary stock by
the central banks, whether as part of conscious policy or
not. At the same time it is felt that the increases in
money supply can be somehow determined by a set of
expectations, and constraints. These approaches, of course,
consider
at
the
same
time,
the
interplay
of
the
expectations of the public and the policies of the central
bank. They also use the concept of credibility of the
government/ central bank.
Def: Credibilty is the extent to which the public
believes that a shift in policy has taken place
when, indeed, such a shift has actually occurred.
(Wilcox)
A policy, to be credible, must be consistent at each
stage with the public's information about the objectives
and constraints facing the central bank. The public will
not believe an announced policy if it knows the policy is
incompatible with the current objectives of policymakers.
(Wilcox).
Fellner (1976) and Haberler (1980), who coined
the term "Credibilty Hypothesis," have stressed that the
less credible disinflationary policies are, the longer and
the more severe their interim adverse effects will be.
2.7
Two approaches
Banks:
to
analyse
the
behaviour
of
Central
Recent research in this direction can be classified
into two:
2.7.1
Positive theories:
As per this view, the objective function facing the
central bankers is of two types:
a)
Social Welfare:
In this approach, the policymaker is thought of
as a
benevolent planner whose major concern is
to
maximize
a
well-defined
social
welfare
function.
b)
Political approach:
In this approach, the importance assigned to
preventing inflation relative to stimulating the
economy is thought to depends on the relative
influence on the central bank of the prostimulation and anti-inflation advocates within
government and the private sector.
This approach can be thought to be
monetarists, since it consideres
discretionary policies and would
favour of a more independent central
2.7.2
deriving from the
the use of nongenerally be in
bank.
Normative theory:
The normative literature focuses on the issue of how,
given the behaviour of central bankers, monetary
institutions can be redesigned to improve social
welfare. (Wilcox:270)
This approach is derived from Keynesian theories, and
advocates
discretionary
approach
and
a
limited
independence to the central banks.
The models generally assume that policymakers are
either "strong" (type 1)
or "weak"(type 2). The weak
policymaker has an incentive to generate inflation. A
strong policymaker always prefers zero infation.
A line
follows:
of
thinking
in
these
models
could
go
as
Initially, the public assigns some probability to the
condition that the policymaker is strong and, therefore,
will not inflate. Weak policymakers are tempted to inflate.
However, since they maximize welfare over several periods,
they have an incentive to appear strong, at least
initially, to discourage inflationary expectations. The
public watches the actions of the policymaker and adjusts
its probability accordingly that the policymaker is strong.
This probability is considered to be a measure of
credibility.
As long as the policymaker does not inflate, the
public assigns some positive probability to the event that
the policymaker is strong. If the policymaker inflates even
one time, however, he immediately reveals himself to be
weak. Because strong policymakers never inflate, there is
no way that a policymaker can re-establish his lost
reputation.
Consequently
once
inflation
starts,
it
continues forever.
last
Research on this area has been taken up only in the
fifteen years or so, and conclusive results are
awaited. It is a very important area of research for the
coming decade.
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PART III
DERUGALATION AND THE CURRENT DEBATE ON THE ROLE OF THE
RESERVE BANK OF AUSTRALIA
IN THE OPERATION OF MONETARY POLICY
===========================================================
Australia entered the nineteen-eighties with one of
the most highly regulated banking and financial systems in
the world.
However, by the end of 1984, deregulation was
almost complete with the removal of range of direct
controls.
3.1
Cause of Deregulation:
To
distinguish
the
main
underlying
cause
of
deregulation of the Australian financial system is no
simple task. There was no single decision "to deregulate".
It would appear that the following were important causal
factors in contributing to this process (More, et.al.:169):
3.1.1
Institutional development
international.
3.1.1.1
-
both
domestic
and
Domestic institutional development:
*
A declining share of financial assets being held
by banks resulted in direct controls over banks
by regulation becoming smaller. The share of the
banking sector declined from 60.5 per cent of the
total assets of the financial institutions in
1936 to only 39.0 per cent in 1985. (Moore,
et.al.:19)
*
The banks themselves had adopted more competitive
attitudes. Some interest rate flexibility and
financial packages had developed.
*
An increase in depth of the market for government
securities enabled the Reserve Bank to place
greater reliance upon open market operations as a
key instrument of monetary policy.
*
The
development
of
the
Treasury
Note
and
Commonwealth Bond tender systems in 1979 and 1982
helped the sale of government securities fixing
the quantity and enabling interest rates to find
their market level.
3.1.1.2
International institutional development
*
The breakdown of the Bretton-Woods system of
fixed
exchanged
rates
in
late
1971
and
introduction of market determined exchange rates
meant that government intervention into foreign
exchange
markets
could
not
override
market
forces.
*
The development of one international
market or international global village.
3.1.2.
finance
Technological Development
Developments
in
communications
and
information
transmission have facilitated the development of innovative
financial products and techniques as competition in the
markets has increased.
Technological change has combined
with deregulation to dramatically change Australian and
international financial markets.
3.1.3
Economic Factors
By the mid nineteen-seventies it was apparent that
direct controls had become an obstacle for effective
economic management.
A further problem in Australia
resulted from the imposition of direct controls over banks
with relative freedom being provided for NBFI's.
This
meant that the Australian monetary authorities were only
able to directly regulate a declining proportion of the
financial system.
3.1.4
Official Reports
The establishment of the Campbell Committee and its
subsequent report, and the report of the Martin Review
Group
were
significant
contributing
factors
to
deregulation.
The Campbell Committee in 1979 provided an
official forum for advocates of deregulation.
The main
recommendations of the Committee with regard to regulation
of the financial system were as follows:
*
The authorities should continue to formulate and
announce
a
monetary
quantity
target.
Alternatives to M3, such as broad monetary and
credit aggregate and monetary base, should be
examined.
Interest rate targeting was rejected
but the authorities should monitor economic
variables as well as the monetary aggregate
targeted.
*
Direct controls over banks should be dismantled
with open market operations remaining as the key
instrument of monetary policy.
*
Prudential
extended.
*
Banks should remain a specialist category
financial
institution
and
continue
to
regulated under the Banking Act.
*
Non-bank financial institutions should be subject
to the same principles of prudential supervision
as banks.
*
The exchange rate for the Australian dollar
should be determined by market forces and
exchange controls progressively dismantled.
supervision
of
banks
should
be
of
be
By the end of 1984, the process of deregulation had
been virtually completed.
Deregulation has meant that:
*
central banks now place little reliance on direct
controls and make more use of markets;
*
more freedom of choice for citizens;
*
more freedom for banks and other financial
institution as to range of business and price
(mainly interest rates);
*
3.2
many more
them.
institutions
and
more
The Role of Reserve Bank of Australia
policy today:
variety
among
in monetary
As mentioned above, the role of RBA has undergone
radical change in the last few years - mainly as a result
of financial deregulation.
So RBA now:
*
influences the economy through anonymous and
impartial financial markets - money, securities
and foreign exchange - not through regulation of
specific institutions; and
*
is concerned with banks and other institutions
which are intermediaries, borrowing on one hand
and lending on the other.(RBA Bulletin:1)
The mehanism of operations of the RBA in the money
markets through the AMMDs have been discussed in the
lecture on the 25th of August.
3.3
The Independence of RBA and
Government: the current debate
its
relationship
with
The relations between the central bank and the
government are complex. Although central banks are part of
the government, they usually have much more independence
from the administration than do such government agencies as
the Treasury Department.
There are several arguments on both sides of the
independence issue.
Supporters of independence argue that
monetary policy, and hence the value of the dollar, is too
important and too complex and issue to be left to the play
of political forces. As Martin, the former chairman of the
Board of Governors of Federal Reserve Bank (the US Central
Bank), put it:
An independent Federal Reserve System is the
primary bulwark of the free enterprise system and
when it succumbs to the pressures of political
expedience or the dictates of private interest,
the groundwork of
(Mayer 1990b:153)
However,
argued that:
William
sound
Proxmire,
money
is
American
undermined.
former
senator,
...independence
is
both
ill-defined
and
circumscribed.
Although no legal method exists
for the President to issue a directive to the
System, its independence in fact is not so great
that it can use monetary policy as a club or
threat to veto Administration action.
The
System's
latitude
for
action
is
rather
circumscribed....In
any
showdown,
no
nonrepresentative group such as the Fed can or
should be allowed to pursue its own goals in
opposition to those of the elected officials.
(Mayer 1990b:152)
However, the trend of thought is now definitely in
favour of more independence since evidence exists to show
that average inflation is least in countries whose Reserve
Banks have greater independence (Economist: p85). Hence the
debate today in Australia is whether the RBA should be
given more independence or not.
In this context, the recent view expressed by the RBA
Governor, Mr. Bernie Fraser (Financial Review: p.1), "With
the benefit of hindsight it might be argued
that the
reluctance to use fiscal policy more vigorously for
counter-cyclical purposes in both the upswing and the
downswing phases of the recent cycle had the effect of
over-burdening monetary policy." Thus the RBA chief has
effectively aligned himself with the recent stimulatory
budget strategy. In other words, he desires a greater coordination between government and the RBA.
On the other hand, the Opposition in Australia desires
the RBA to be given greater independence to enable it to
reach a lower inflation rate using the interest rate
mechanism. The RBA chief has serious disagreement with
this.
It appears that Australia is not going to have an
independent Reserve Bank in the near future.
Reference:
---------Auerbach, Robert D. Money, Banking, and Financial
Markets. 3rd edn. 1989. Macmillan Publishing Co.,
London.
Australian Financial Review. 18.8.92
Bandyopadhyay, Taradas and Ghatak, Subrata.(ed)
Current Issues in Monetary Economics.1990.Harvester
Wheatsheaf, London.
Economist. February 2nd, 1991.
Frisch, Helmut. Theories of Inflation. 1983. Cambridge
University Press, Cambridge.
Gittins, Ross. Gittins' Guide to Economics.2nd
edn.1989. VCTA Publishing, Victoria.
Juttner, Johannes, D. Financial Markets, Interest
Rates and Monetary Economics. 2nd edn.1990. Longman
Cheshire, Melbourne
Mayer, T.,et.al. Money, Banking and the Economy.1990b.
W.W.Norton and Company, New York
Mayer, Thomas (ed.).The Political Economy of American
Monetary Policy. 1990a. Cambridge University Press.
New York.
Moore, David; Lyell, Don, et.al. Financial
Institutions and Markets.1988.Serendip Publications.
Parkin, Michael and Bade, Robin. Macroeconomics and
the Australian Economy.2nd edn.1990. Allen and Unwin,
Sydney
Reserve Bank of Australia Bulletin. June, 1988.
Vaish, M.C. Macroeconomic Theory.6th edn.1980. Vikas
Publishing House, New Delhi.
Wilcox, James A.(ed) Current Readings on Money,
Banking and Financial Markets. 1988. Scott, Foresman/
Little.