Mishkin weighs merits of monetary options in developed and emerging market countries

• Author: Mark Stone
• Position: Monetary Operations Division. IMF Monetary and Exchange Affairs Department
• Pages: 353-355

Page 353

In an October 6 seminar at the IMF Institute, Fredric S. Mishkin of Columbia University examined what has worked—and not worked—in monetary policy regimes.

He relied heavily on a case study approach, he explained, because in determining the effectiveness of monetary policy design, the “devil is in the details.” He explored the relative strengths and drawbacks of regimes built around exchange rate, monetary, and inflation targets, and questioned the longer-term suitability of the “just do it” approach in the United States.

In particular, Mishkin assessed the different benefits of “nominal anchors” available to emerging market countries. Full public awareness of the nominal anchor, which is the goal of monetary policy, brings transparency and accountability to the policymaking process, he said. And this, in turn, can constrain discretionary monetary policies that produce “time-inconsistency” problems—short-term decisions that lead to less desirable long-run outcomes.

Two themes in Mishkin’s presentation highlighted the importance of country-specific circumstances that lie outside the traditional purview of monetary policy. First, political economy considerations are increasingly crucial elements in the design of successful monetary policy. Institutions need to achieve a high degree of transparency and accountability, but this will mean attuning the design of these institutions to the history and dynamics of the domestic political setting. Second, effectively communicating monetary policy strategy to the public is another key prerequisite for success. This, too, willPage 354 require tailoring the means of communication to individual country circumstances and needs.

Exchange rate targeting

Exchange rate targeting entails “importing” the monetary policy of a large, stable trading partner. Typically, the exchange rate is pegged at a given rate of exchange to that of the partner and adjusted over time to account for inflation differentials. Exchange rate targeting anchors the public’s inflation expectations to that of a low-inflation country, and the automaticity of the policy mitigates the time-inconsistency problem by removing discretion. Moreover, the targeted exchange rate is transparent and understood by the public. During the early and mid-1990s, many European countries used exchange rate targeting to successfully reduce inflation.

A loss of monetary policy independence is the main disadvantage of exchange rate targeting. In 1990, for example, an increase in German interest rates—aimed at stemming postunification inflationary pressures— was shifted to fellow members of the European Exchange Rate Mechanism such...