The goals of monetary policy were macroeconomic, but the precise targets the exchange rate, inflation, unemployment, monetary aggregates and instruments interest rates, moral suasion, monetary base varied. In the Chancellor granted independence over interest rate policy to the Bank of England.
The work of Kydland and Prescott and Barro and Gordon on the time consistency of optimal policy created the theoretical case for an independent central bank. Empirical work e. Alesina and Summers supported the argument that the more independent a central bank, the lower the inflation rate. Notably, advocates of central bank independence wrote in and about an environment devoid of expensive military engagements, one in which the monetary role took central stage away from the financial stability role.
The Bank of France had less independence than the Bank of England in the 19th century, although it too was privately owned. Goodhart argues that in the 19th century the Bank of France evolved into a lender of last resort. As in Britain, the events of the first half of the twentieth century changed the status of the Bank of France. The extent of depreciation, and its obverse, the rate of inflation had immediate consequences for the distribution of wealth and essentially who would pay for the war, and the early twenties saw continual conflict between Treasury and the Bank as to how much the Bank would finance government debt.
Finally, in the Poincare stabilization fixed the value of the franc at a value that enriched Treasury and eliminated the conflict between the Bank and Treasury until the mids, when after the election of the Popular Front the same conflict arose. In , the Bank of France was granted independence from political processes and a mandate for price stability, as a prelude to joining the European System of Central Banks.
The Bank of Japan followed a similar path. As noted above, the Bank had limited independence from the outset, but even that was reduced in when the "Act of " required the bank to act in the national interest -that is, to support the war effort.
Following the war, a number of amendments to the Act of gave greater flexibility to the bank and, as in England and France, the major shift occurred in effective when the bank's mandate was amended to incorporate both price stability and financial stability, and the bank was required to operate with 'transparency and independence'.
The 'system' nature of the Federal Reserve led to a more complex set of debates as the Federal Reserve Board fought for power against the individual Federal Reserve Banks, as well as against the Federal government.
After the passage of the Act, all trade in government securities had to be approved by the Federal Open Market Committee FOMC now comprising all of the board members and 5 regional presidents. The Treasury Accord signed in March was an agreement between the Secretary of the Treasury and the Chairman of the Board of Governors of the Federal Reserve which ended the Fed's commitment to a fixed low interest rate on Treasury securities.
The Accord was far from cordial. From the late s, the Fed had worried about rising inflation and chafed at the ceiling on bond prices to which they had agreed during the war. Tensions were exacerbated as the Korean War was going badly, thus raising inflation fears.
In late , the Secretary of the Treasury declared publically that new debt issues would be financed at the existing rate. The New York Times reported: "[L]ast Thursday constituted the first occasion in history on which the head of the Exchequer of a great nation had either the effrontery or the ineptitude, or both, to deliver a public address in which he has so far usurped the function of the central bank as to tell the country what kind of monetary policy it was going to be subjected to" Hetzel and Leach, The impasse was ultimately resolved by McChesney Martin Assistant Secretary of the Treasury and Fed staff members who negotiated an agreement whereby the Fed would keep the discount rate at 1.
While typically less dramatic than the fight between the Federal Reserve and the Treasury, establishing the relationship between the Department of Finance and the Bank of Canada also took time and a very public dispute. The critical juncture occurred in In the late s the Bank of Canada reacted to rising inflation imported from the US -Korean War by raising the bank rate basis points in 18 months Bordo et al.
The result was the appreciation of the Canadian dollar and high unemployment to which the federal government responded by fiscal expansion. The governor of the bank, James Coyne, argued publically that fiscal expansion was bad for the economy, while academic economists and most commentators argued publically that high interest rates were bad for the economy. The Minister of Finance asked for the resignation of the governor in May , which the Governor refused to tender.
The minister then introduced legislation declaring the position of Governor of the Bank of Canada to be vacant. The legislation passed the House of Commons in July, but was rejected by the Senate.
The governor then resigned. The new governor accepted the position conditional on clarification of the relationship between the government and the bank. The memo -which defines the relationship today- requires that should a conflict over monetary policy between the two occur the government would issue a directive to the governor dictating policy.
The 'directive' must be published in the Canada Gazette and it is widely understood that the governor would then resign. The directive power resolves issues of extreme disagreement, but is essentially MAD -mutually assured destruction- and does not actually address the more mundane determinants of monetary policy.
Since , that issue has been resolved implicitly. Such agreements have been issued each subsequent five years. The Bank of Canada has spent much of the last 5 years considering alternative targets for prices -the target rate, price level versus inflation targeting, CPI vs.
Most central banks provided some fiscal benefit to the government but this was a stable amount, except during extraordinary times in times of war when further assistance was expected and, indeed, required. Central banks understood that they were the lender of last resort in the Bagehot sense of lending at a penalty rate to solvent but illiquid financial institutions. They did not see themselves as playing a macroeconomic role either in stabilizing the economy or in promoting growth. They had a monopoly over note issue but did not provide the nominal anchor for the economy as the gold standard played that role.
Finally, the central banks were almost all privately owned, often predominantly by the private banking sector. By mid-century the picture had changed. During the tumultuous period of war and depression all the central banks were expected to play a macrostabilization role, and after WW II the private central banks were nationalized, thus making it clear they were instruments of the state in peacetime as well as in wartime.
Over the next few decades, central banks were expected to follow policies that fine-tuned the economy, keeping inflation and unemployment low.
The experience of stagflation in the s changed the attitudes of central bankers and by the s the goal of most central banks was narrowly focused on low inflation. Once a single goal was accepted that is, trade-offs no longer needed to be made , the case for independence of the central bank was easy to make. Economic theory and empirical evidence supported the argument that independent central banks lowered inflation, and Germany was the poster child for this case.
The case for a European Central Bank became clearer. Finally, the 'great moderation' and widespread belief in the efficiency of financial markets reduced the significance attached to the financial stability role of the central bank. If markets could support illiquid but solvent financial institutions, then there would be no need for a lender of last resort.
The nature of the medium of exchange has evolved over the last few centuries, and while I'm not sure what the implications of this are for central banking I'm pretty sure they will be profound. In the 17th century, throughout most of Europe, coin was the dominant medium of exchange, and the only means of final payment. Banks existed notably in Italian cities , but they were banks of deposit rather than noteissuing banks.
With the obvious exception of the European Central Bank, all the major central banks began operations during the period when note issues were tied to gold.
The central banks did not see themselves as creating a nominal anchor for the economy -that was done by tying the definition of the unit of account to a weight of gold. Through the twentieth century the link to gold was attenuated to the point where in it disappeared Redish, But the nominal anchor had never actually been the gold standard; instead, it was always the political commitment to maintain that unit of account. The fiscal role of central banks dominated in the early days of central banking.
In an economy whose primary form of money was coins, the fiscal authority could generate revenue by debasing the coinage. Today, mature central banks would not identify the earning of seignorage revenue as a significant goal.
As the nature of money changed, the methods to provide a nominal anchor changed in parallel. As long as money was coin, the challenges other than addressing fiscal goals were those of dealing with foreign exchange issues and with the effect of the wear and tear on the value of the standard. These were not easily resolved: at a broad brush level, erosion of the coinage led to a gradual debasement as the weight of coins of given nominal value declined.
The creation of bank notes and fractional reserve banking raised the challenge of how to control the quantity of money, as well as creating problems for financial stability. The monetary control problem was typically addressed through limits on the amount of note issue. In the US, the federal government taxed the issue of state bank notes, and the national banks became monopoly providers of bank notes. In both countries, limits on bank note issue created incentives to develop other monetary media and chequable bank deposits became an important, and then dominant monetary medium.
In the early post-WW II period, the reserve ratio was viewed as an important tool of monetary policy since it was argued that the stock of money was a reasonably constant multiple of the stock of reserves. This in turn encouraged the use of monetary aggregate targeting whereby control of the stock of reserves would control the rate of growth of the money stock.
The result was again that induced innovation led to new monetary forms such as NOW accounts. Monetary aggregate targeting was abandoned after less than a decade in the countries that tried it.
Goodhart's law states that, "Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes" and was coined in the context of these attempts at monetary control.
It likely applies to attempts to use capital adequacy ratios as well. For example, if equity an expensive form of capital must be held against assets depending on the risk weight they are assigned then there is a premium on finding assets whose risk is understated and on holding more of them.
More significantly, there is an incentive to find ways to get risky assets off the balance sheet -for example, by securitization. Understandably, using credit ratings as a mechanism to weight assets put more burden on the credit rating mechanisms than they were designed to bear. Central banks have fulfilled a number of mandates -providing monetary unification, uniformity and stability, generating fiscal resources, acting as a tool for macroeconomic stability, and enhancing financial stability.
In different periods, different motives have taken pride of place. In western economies the macroeconomic motive dominated after World War II; during the last two decades of the 20th century the monetary stability e. Financial and monetary developments in T he young government of workers and farmers class faced great challenges in solving urgent livelihood issues, consolidating and strengthening their government power, and at the same time, defending their new state from sabotage conducted by the French colony and other anti-revolutionary forces.
The revolutionary government faced many financial challenges: just over 1. Responding to an appeal by President Ho Chi Minh in December , the whole nation entered into a long struggle of resistance against the French co lony.
The government also increased its revenues through various measures, such as issuing Resistance War Bonds, National Bonds, On February 3, , the Production Credit Office, the first credit institution in Vietnam, was established to provide funds for production restrict usury in rural areas, facilitate policies to reduce interest rates, and finance collective businesses.
The 2nd National Party Congress February set new economic and financial policies. These policies clearly stated that fiscal policy must be closely combined with economic policy. They also approved the creation of Vi etnam National Bank and issued new bank notes to stabilize monetary policy and improve the credit mechanism. The banking network expanded to serve districts and towns, while the number and qualification of banking professionals were improved.
In the period — , the SBV fostered the credit expansion to support economic recovery, especially for the growth of collectives, the development of small and handi craft industrial production and the financing of state-owned enterprises. The SBV made tremendous improvements in non-cash payment and acceleration of payment performance with almost enterprises and state entities.
It also focused on managing and expanding the foreign exchange mobilization to serve for the country rehabilitation. By the end of , the SBV had cooperative relations with banks from 41 countries around the world. Due to these hostilities, the SBV had to redirect its activities to adapt to the wartime conditions. In order to meet requirements for product ion, livelihood, and fighting the war, the SBV improved and expanded its credit, payment, cash management relationships; managed state budget funds; helped enterprises relocate, disperse, and increase their production; promoted bank credit for state-owned and collective enterprises; mobilized foreign currency revenues and ensured smooth international payments.
Non-cash payments in this period averaged In , the requirement of urgent spending for the South front including finance and cash increase d enormously. B— 68 delegation was assigned in to 14 groups located from the Province of Binh Tri Thien to the southern provinces. Among them, the group of officials working for the Central Party of South Vietnam coordinated with local officers to establish Treasure and Credit Council R namely C The group of C32 officers were the silent comrades acting in a confidential, dangerous, difficult and lacking conditions, but they were extreme loyal the faithful , clever, brave, creative and exceptionally fulfilled the task of receiving and transporting foreign exchange, ensured safety for thousands of USD million to timely serve for South battles and effectively took over the banking system of the former Saigon regime after the liberation of Saigon.
Financial and monetary developments in — The Fed buys government securities from securities dealers, supplying them with cash, thereby increasing the money supply. The Fed sells securities to move the cash into its pockets and out of the system. The first prototypes for modern central banks were the Bank of England and the Swedish Riksbank, which date back to the 17 th century. The Bank of England was the first to acknowledge the role of lender of last resort.
It was principally because European central banks made it easier for federal governments to grow, wage war, and enrich special interests that many of United States' founding fathers—most passionately Thomas Jefferson—opposed establishing such an entity in their new country.
The National Banking Act of created a network of national banks and a single U. The United States subsequently experienced a series of bank panics in , , , and In response, in the U. Congress established the Federal Reserve System and 12 regional Federal Reserve Banks throughout the country to stabilize financial activity and banking operations.
Between and , when world currencies were pegged to the gold standard , maintaining price stability was a lot easier because the amount of gold available was limited. Consequently, monetary expansion could not occur simply from a political decision to print more money, so inflation was easier to control.
The central bank at that time was primarily responsible for maintaining the convertibility of gold into currency; it issued notes based on a country's reserves of gold. At the outbreak of World War I, the gold standard was abandoned, and it became apparent that, in times of crisis, governments facing budget deficits because it costs money to wage war and needing greater resources would order the printing of more money.
As governments did so, they encountered inflation. After the war, many governments opted to go back to the gold standard to try to stabilize their economies. With this rose the awareness of the importance of the central bank's independence from any political party or administration.
During the unsettling times of the Great Depression in the s and the aftermath of World War II, world governments predominantly favored a return to a central bank dependent on the political decision-making process.
This view emerged mostly from the need to establish control over war-shattered economies; furthermore, newly independent nations opted to keep control over all aspects of their countries — a backlash against colonialism. The rise of managed economies in the Eastern Bloc was also responsible for increased government interference in the macro-economy.
Eventually, however, the independence of the central bank from the government came back into fashion in Western economies and has prevailed as the optimal way to achieve a liberal and stable economic regime.
Over the past quarter-century, concerns about deflation have spiked after big financial crises. Japan has offered a sobering example. After its equities and real estate bubbles burst in , causing the Nikkei index to lose one-third of its value within a year, deflation became entrenched. The Japanese economy, which had been one of the fastest-growing in the world from the s to the s, slowed dramatically. The '90s became known as Japan's Lost Decade. The Great Recession of sparked fears of a similar period of prolonged deflation in the United States and elsewhere because of the catastrophic collapse in prices of a wide range of assets.
The global financial system was also thrown into turmoil by the insolvency of a number of major banks and financial institutions throughout the United States and Europe, exemplified by the collapse of Lehman Brothers in September In response, in December , the Federal Open Market Committee FOMC , the Federal Reserve's monetary policy body, turned to two main types of unconventional monetary policy tools: 1 forward policy guidance and 2 large-scale asset purchases, aka quantitative easing QE.
The former involved cutting the target federal funds rate essentially to zero and keeping it there at least through mid But it's the other tool, quantitative easing, that has hogged the headlines and become synonymous with the Fed's easy-money policies. QE essentially involves a central bank creating new money and using it to buy securities from the nation's banks so as to pump liquidity into the economy and drive down long-term interest rates.
In this case, it allowed the Fed to purchase riskier assets, including mortgage-backed securities and other non-government debt. This ripples through to other interest rates across the economy and the broad decline in interest rates stimulate demand for loans from consumers and businesses. Banks are able to meet this higher demand for loans because of the funds they have received from the central bank in exchange for their securities holdings.
While the ECB was the first major central bank to experiment with negative interest rates , a number of central banks in Europe, including those of Sweden, Denmark, and Switzerland, have pushed their benchmark interest rates below the zero bound. The measures taken by central banks seem to be winning the battle against deflation, but it is too early to tell if they have won the war. Meanwhile, the concerted moves to fend off deflation globally have had some strange consequences:.
In Japan and Europe, the central bank purchases included more than various non-government debt securities.
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