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Money Markets and Politics

A Study of European Financial Integration and Monetary Policy Options

Jens Forssbæck and Lars Oxelheim

The dramatic evolution of financial markets in the 1980s and 1990s, accompanied by increasing institutional integration between nations (most notably in the EU), have fostered a widespread belief that governments – particularly those of small economies – have essentially lost the power to pursue sovereign, independent economic policies. At the same time, it is widely assumed that the loss of monetary-policy control is a major opportunity cost for a country adopting a rigid exchange-rate regime or, in the European context, for countries joining the EMU This book sheds light on these arguments.
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Chapter 4: Money Market Development and Monetary Policy Operations

Jens Forssbæck and Lars Oxelheim


The reforms of strategic as well as of operational aspects of monetary policy in the last 20-year period on the one hand, and financial deregulation and innovation (as described in Chapter 3) on the other, are part and parcel of the same process. The operational framework of monetary policy is intimately related to the institutional environment in which it is conducted, and the evolution of the practical aspects of policy-making interplays in a complex way with the general path of market development. For example, the structure of the money market determines the extent and type of open market operations that are feasible; conversely, evidence and experience indicate that favorization by the monetary authorities of market-oriented policy instruments helps to foment a broader market development. In this chapter, we will study to what extent developments in the domestic money markets of our 11 focus countries have altered the conditions for practical monetary policy-making – that is, for the procedures used by monetary authorities to implement policy. An implicit assumption underlying the discussion in the chapter is that studying the domestic conditions in this area may provide important insights to how exposed domestic monetary policy is to competitive forces in the different countries. We will also discuss whether changes in central bank operating procedures have, in themselves, contributed to money market development. The cross-country studies that exist1 consistently indicate that changes in the operative frameworks of central banks have been both effects and drivers of broader changes in the financial and monetary environment,...

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