Discretionary policy with the advantage of flexibility

‭Discretionary policy with the advantage of flexibility‬ ‭In practice, BC modulates their interventions without resorting to an explicit rule but in a pragmatic‬ ‭ anner - flexible and therefore discretionary strategies.‬ m ‭Keynesian Favorable‬‭to this: action on Ti can be an‬‭effective instrument of economic policy via I‬ ‭multiplier. Can‬ ‭also be effective because it surprises the agents - multiplies the effects. (See‬‭ISLM‬‭)‬ ‭NEC‬‭:‭o ‬ pposed to this vision - hypothesis of rational‬‭expectations (effect‬‭Ricardo Barro‬‭).‬ ‭ -‬‭Monetary policy is subject to constraints:‬ 2 ‭a)‬ ‭The debate on the independence/credibility‬ ‭of the central bank‬‭How to ensure the credibility‬‭of‬ ‭the BC:‬‭3 criteria of independence:‬ ‭ )‬ 1 ‭organic autonomy‬‭:long mandate of governors, out of‬‭sync with political‬ ‭cycles. 2)‬‭functional autonomy‬‭:BC capacity to define‬‭its objectives AND the‬ ‭instruments to achieve them. 3)‬‭Financial autonomy‬‭:BC‬‭can implement its policy‬ ‭with sufficient resources.‬ -‭ Independence from political power = condition of credibility. Policy deemed credible if agents have‬ ‭confidence in the BC which must put everything in place for price stability. Credibility is achieved‬ ‭on LT. -‬‭Explains the great rigor of the ECB since‬‭its creation (1999)‬‭to fight inflation and gain‬ ‭market credibility. To guarantee autonomy and avoid the temptation to finance the public deficit‬ ‭through inflation, the ECB can no longer finance it directly since 2007 (Lisbon Treaty).‬ ‭ redibility issues for central banks:‬ C ‭Increasing power of monetary markets - agents' expectations have a great influence - requires‬ ‭monetary authorities to evaluate the impact of their decisions on the evolution of agents' behavior.‬ ‭-If decisions taken by BC are contrary to price stability - modify agents' expectations‬ ‭in the direction of inflationary behavior - calling into question the effectiveness of‬ ‭monetary policy:‬ ‭NEC:‬‭F. Kydland‬‭And‬‭E. Prescott:‬‭The inconsistency of‬‭optimal plans‬‭,‭1 ‬ 977‬‭Inconsistency when‬ ‭monetary authorities commit to inflation and the objective is abandoned (eg: political-economic‬ ‭cycle: unemployment is favored over inflation) - agents anticipate price increases that they will‬ ‭integrate into their negotiations, leading to inflation.‬ ‭Expansionary monetary policy can be effective at CT if surprised, but calls into question the‬ ‭credibility of the CB.‬ ‭ )‬ b ‭Does an independent central bank fight inflation more‬ ‭effectively?‬‭Independence of central banks and fight against‬ ‭inflation:‬ ‭Relationship between degree of independence and inflation - in theory, we expect that the more a‬ ‭CB is independent, the less inflation is high.‬‭R. Barro‬‭And‬‭D.Gordon‬‭:‬‭if monetary policy of a‬ ‭non-independent CB - inflationary bias.‬ ‭-Negative correlation between autonomy and inflation (but low intensity). We can also wonder about‬ ‭the direction of causality: perhaps it is low inflation which leads to high autonomy.‬ ‭ he independence of CBs is neither a necessary nor sufficient condition to fight against‬ T ‭inflation: chicken game‬‭Disinflation policy in the‬‭80's in industrialized countries achieved the‬ ‭objective even though most BCs were not independent (not all). Lower inflation rate in France‬ ‭linked to modification of VA pay (deindexation of salaries), while Banque de France remained‬ ‭dependent on political power.‬ ‭ . Nordhaus‬‭,‬‭policy games‬‭1994:‬‭if cooperation between‬‭monetary and budgetary‬ W ‭authorities is insufficient - can result in a "destructive game" - independent BC which‬ ‭would conduct a very restrictive policy could see its action counterbalanced by an‬ ‭expansive budgetary policy which compensates for recessive effects of policy‬