Implications and Relevance
Edited by Phillip Arestis, Michelle Baddeley and John S.L. McCombie
Chapter 14: International aspects of current monetary policy
14. International aspects of current monetary policy L. Randall Wray 1. INTRODUCTION This chapter will examine monetary policy appropriate for an open economy operating with a ﬂoating exchange rate. It will be shown that most of the conventional wisdom regarding each of the following issues is ﬂawed: interest rate determination; ability of the central bank to ‘pump liquidity’ into an economy to ﬁght deﬂation; central bank ‘monetization’ of budget deﬁcits; central bank ‘sterilization’; the relation between the ‘twin deﬁcits’ and their impacts on exchange rates. Brieﬂy, the central bank sets the overnight interest rate target and then supplies or drains reserves to ensure banks have the quantity desired and/or required. The central bank can always ‘pump’ excess reserves into the system, but this will simply result in a zero-bid condition in the overnight market, causing overnight rates to fall to zero (or to the support rate if the central bank pays interest on reserves). The treasury spends by crediting bank accounts and taxes by debiting them – deﬁcits simply mean that bank accounts have been net-credited; hence reserves have increased. If this has created a position of excess reserves, the central bank or treasury must sell bonds or the overnight rate will fall. Hence there is no operational meaning to be attached to the notion of central bank ‘monetization’ of deﬁcits. Central bank operations are always defensive, and if international payments cause actual reserves to deviate from desired/required reserve positions, the central bank has no...
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