Monetary policy

Roberto Bonfatti, Adam Brzezinski, K. Kıvanç Karaman, Nuno Palma, 27 September 2020

Monetary capacity refers to a state's capacity to circulate money that is accepted by the public, while fiscal capacity refers to its capacity to tax. This column argues that monetary and fiscal capacity and, by extension, markets and states have a symbiotic relationship. The long-run European evidence from antiquity to the modern period corroborates this mutual dependence, with money stocks and tax revenues moving in close synch. History also offers a natural experiment to estimate the causal effect of monetary capacity on fiscal capacity, with New World silver increasing money stocks and in turn tax revenues in a significant and substantial way.

Josef Bajzík, Tomas Havranek, Zuzana Irsova, Jiri Schwarz, 23 September 2020

A key parameter informing policy models in international economics is the elasticity of substitution between domestic and foreign goods, also known as the Armington elasticity. Yet elasticity estimates have varied widely since Armington’s seminal 1969 contribution. This column considers 3,524 previous estimates and discusses how these historical analyses can be corrected for various biases. The previous research implies that the elasticity lies in the range 2.5-5.1 with a median of 3.8. In a simple model this translates to a trade cost elasticity of 2.8. 

Marco Del Negro, Michele Lenza, Giorgio Primiceri, Andrea Tambalotti, 18 September 2020

The analysis of inflation dynamics and their possible changes over time is a key input in the design of monetary policy, particularly in the context of the strategy reviews recently undertaken by the Federal Reserve and currently under way at the ECB and other central banks. This column studies the causes of the stability of US inflation over the business cycle since the 1990s. It concludes that the stability is mainly due to a reduced sensitivity of firms’ pricing decisions to their cost pressures. Ignoring this observation could impair the ability of monetary policy to steer inflation toward its objective.

Márcia Pereira, José Tavares, 17 September 2020

Crises such as the sovereign debt crisis and the current Covid-19 crisis place significant pressure on European institutions, raising scepticism over policy decisions and speculation as to how member states’ differing needs are taken into account. This column uses estimated counter-factual country-specific interest rates to extract the country weights implicit in the ECB’s conventional monetary policy. Germany, Belgium and the Netherlands are associated with the largest weights, and Greece and Ireland with the smallest. Nonetheless, the weights of the larger economies are smaller than their output and population shares. The results change minimally when the crisis period is compared with the period before. In sum, while weights differ across countries, they do not seem to unduly weigh larger economies. Further, estimated country weights are positively correlated with the degree of co-movement between each country’s and Germany’s business cycles.

Ignazio Angeloni, 14 September 2020

The long-awaited outcome of the Federal Reserve’s monetary strategy review is finally out. This column argues that while the ‘Powell doctrine’ responds to a genuine need to address issues in the Fed’s policy framework, it also introduces complexities in the interpretation and implementation of monetary policy which are likely to become more apparent over time. The hurdles involved do not have easy solutions, and other central banks pondering their own monetary policy framework are well advised to take heed.

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