Monetary theory and policy

The aim of this paper is to explore the contrasting views of inflation,
exchange rate misalignments and determinants of gold flows held by different branches of the classical school during the first half of the nineteenth century. The properties of money neutrality and money
endogeneity within the classical system are studied by reinterpreting these controversies through the analytical framework of the surplus approach as reconstructed by Sraffa [Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press, 1960] and his followers.

h i g h l i g h t s • We propose a refinement of Ascari's (2004) model by introducing two theoretical important ingredients. • We propose a re-evaluation of the macroeconomic effects of non-zero trend inflation. • The omission of some important theoretical ingredients significantly distorts the results obtained to date. a b s t r a c t To date, most of the papers which have examined the effects of trend inflation on the properties of New Keynesian model were based on relatively simple sticky-prices DSGE models and whose realism was sometimes questionable. In this paper, we re-evaluate the macroeconomic effects of non-zero trend inflation. Building on the model of Ascari (2004) as one of the most-cited papers in the literature on the effects of trend inflation, we show that the omission of some important theoretical ingredients significantly distorts the results obtained to date. We propose a refinement of this model by introducing two theoretical important ingredients, namely investment adjustment costs, and a roundabout production structure. Once we add these features to make the model more realistic, as commonly for medium-scale models, we find that the standard New Keynesian model without real frictions overestimates the short-term macroeconomic effects of a positive trend inflation rate and underestimates those of the long term.

"Could either monetary policy or financial prudential regulation be relied on individually to mitigate asset price cycles or their effects? If both ways are effective, monetary policy and prudential regulation could then be considered “substitutes,” in
the sense that the individual use of either instrument leads to a reduction in the volatility of both corresponding targets. This
note, however, argues in favor of complementarity—rather than substitution—in the use of monetary and macroprudential policies: the combined (articulate) use of both policies tends to be more effective than a standalone implementation of either."

The Monetary Dialogue between the European Parliament and the ECB is a major factor in assuring the legitimacy of European institutions. This note provides new evidence in the efficiency of the Dialogue for the crisis management and presents the results of a survey conducted among the members of the ECON Committee.

Neoclassical economics uses real analysis and this approach limits its applicability to practical economic problems, including policy applications. Joseph Schumpeter and later John Maynard Keynes himself rejected the approach of real analysis and the notion of money neutrality. They argued that to understand the changes in the economy requires closer reflection of the crucial importance of credit and money. Schumpeter and Keynes promoted monetary analysis as the proper method to analyze the modern economy. This book joins their instructive criticism by raising doubts about the traditional views on interest rate. We deal with a new theory of money and interest rate and I show that Wicksell’s classical concepts of the natural (real equilibrium) rate of interest would not give guidance for contemporary monetary policy practitioners. These terms are unobservable. The natural rate apparently became unstable after the global financial crisis. Such concepts of interest rates are key variables of real analysis, but they are inherently uncertain, and imprecise. There is a growing dissatisfaction with traditional macroeconomic approaches based on the notion of money neutrality in real analysis.
The endogenous theory of money highlighted the importance of money created by commercial bank credit. The central bank’s presumed control over money became questionable. Central banks determine interest rates (short term and nominal) but the quantity of money is determined endogenously. Macroprudencial and liquidity requirement regulations -- which are important factors in influencing commercial bank lending and endogenous money creation -- became the most important instrument the central bank can use to control money.
With respect to money creation, we distinguish between inside and outside money. Inside money is created by the private sector’s need for money helped with bank credit. Outside money is created by the state (not the private sector), but its creation is indirectly influenced by the money demand of the private sector.
We give a brief overview of the historical process of the emergence of money by comparing the main elements of the chartalist and metallist concepts of money. Concerning the current debates about the role of banks in money creation we compare three alternative theories of banking. All three are in conflict with each other in explaining even the basic facts, and yet still they live in peaceful coexistence in textbooks. These three theories treat the role of banks in money creation differently. According to one of the theories, banks simply act as intermedieries in channelling savings to borrowers, and play no part at all in money creation. Another set of theories maintains that individual banks are unable to create money, since they cannot print banknotes, but the banking system as a whole can create money in a manner governed by the central bank by the money multiplier process. According to the third theory banks may create money independently from the central bank endogenously through credit creation. The description of today’s money flows and the interpretation of today’s monetary policy is only possible through the endogenous money theory.
Globally important central banks will increase their interest rate eventually. However, at low interest rates a relatively small increase may lead to significant losses in portfolios with longer duration. Investment funds in their effort to minimize losses by shortening the duration of their portfolios may trigger abrupt changes in capital flows. Increased volatility may undermine financial stability. This type of stability risk is independent of the country’s liquidity situation or weather the banks are well capitalized or profitable. Such systemic risks cannot be managed by macroprudential tools but these tools remain an integral part of monetary policy management.
Keywords: endogenous money, interest rate, money multiplier, monetary policy, Post-Keynesian, macroprudential regulation
JEL: E12, E43, E51, E52, E58, G28

This study applied the Index of Institutional Quality (IQ) methodology to measure the level of independence of the Reserve Bank of Malawi (central bank) and examine its impact on inflation. The IQ methodology assesses independence of central banks based on their actual practices. The methodology is suitable for developing countries whose practices do not fully conform to the laws of Banks that are in place. The study finds that the average independence index of the Reserve Bank of Malawi (RBM) is 15.1, which is more than half below the total index value of 36. This clearly shows that the RBM is not convincingly independent. Although the results show an above-average value for index of monetary policy independence, indications are that the RBM is not free from political pressures as evidenced by below-average values for indices of political and fiscal independence. Using Ordinary Least Square (OLS), the results further show that the low degree of independence by the RBM has contributed to high inflation in Malawi.