Nominal Anchor

4 Key excerpts on "Nominal Anchor"

• 

  eBook - ePub

  Exchange-rate Policies For Emerging Market Economies

  • Richard J Sweeney(Author)
  • 2019(Publication Date)
  • Taylor & Francis

    (Publisher)

  Chapter 3 by Wihlborg and Willett in this volume). Such countries should adopt domestically rather than internationally based anchors. The final section offers brief concluding remarks.

  What Is a Nominal Anchor?

  The term Nominal Anchor is used in two ways in the literature. Anchors are described as (1) long term, fixed, and nonadjustable, or (2) short term, temporary, and adjustable. In both cases, Nominal Anchors are viewed as targets for monetary policy (Flood and Mussa 1994). If the definition of an anchor is a target for monetary policy, then both descriptions are consistent. If a government hopes to gain long-run discipline and credibility from an anchor, then only the first description is appropriate.

  In the debate surrounding the use of exchange rates as Nominal Anchors, analysts often fail to explain whether they view the exchange rate anchor as temporary or permanent. Quite frequently reference is made to Nominal Anchors without definition or discussion of their meanings. Because the emphasis is often on discipline and credibility effects, the idea of anchors as long-run constraints is usually strongly implicit (Corden's 1994 paper is an exception in that he explicitly discusses the time dimension). Frankel is quite explicit in describing the Nominal Anchor argument as "a prescription to peg exchange rates firmly as a credible precommitment on the part of monetary authorities not to inflate" (1996:153). Clearly such a definition is not consistent with treating a temporary peg as part of a Nominal Anchor strategy, yet one frequently encounters references to changeable or temporary Nominal Anchors (see, for example, Bruno 1991b, Claassen 1991, Cooper 1991, Edwards 1997, and Paredes and Sachs 1991). Indeed, policies are often implemented in which the exchange rate is used as a short-term Nominal Anchor, meant to be abandoned at some unspecified future date, and yet credibility effects are often assumed. For example, Sachs (1997:250) argues that an important argument in favor of temporary pegging at the beginning of a stabilization program is its symbolic value: "the commitment to a pegged exchange rate is a very visible signal of the government, that may increase confidence and stop a flight from the currency." Likewise, Bofinger et at (1997:19) argue that "if a central bank adopts an exchange rate target, this reflects a strong commitment to macroeconomic stabilization." Exchange rate pegging is certainly a strong indicator that the government is undertaking a major stabilization effort, but we question whether it should convey a credible signal to economic agents that the stabilization programs will be sustained long enough to succeed. Indeed, writers such as Calvo and Végh (1994) and Kiguel and Liviatan (1992, 1991) offer imperfect credibility as an explanation for why exchange rate based stabilization in chronic high inflation countries often leads to an initial boom.7

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Frameworks for Monetary Stability : Policy Issues and Country Experiences

  • INTERNATIONAL MONETARY FUND(Author)
  • 1994(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  Given the close integration of European economies, the anchor country in pursuing its own goal of price stability does in effect take into account economic conditions in other countries, but only to the extent that they affect its own inflation rate. Its monetary authorities, with their strong anti-inflation credentials, can no doubt from time to time give additional weight to circumstances in neighboring countries, without affecting their credibility or the strength of the anchor. However, once the anchor country begins to adapt its policies to the needs of follower countries on a regular basis, or for a sustained period, especially in face of domestic inflationary pressures, its role as anchor begins to become blurred. If there is a consensus that a coordinated approach to policy is to become a general feature of policies, a common anchor would be required, such as the common monetary policy that will underpin EMU. Other papers in this book deal with monetary union in Europe.

  The Choice of Nominal Anchor . The exchange rate anchor has lost some of its lustre after the recent year-long crisis in the ERM, rekindling the debate on the appropriate orientation for monetary policy in European countries and with this debate have come proposals for alternative anchors. While a detailed consideration of such issues goes beyond the scope of this paper, a few comments may be helpful. First, as discussed earlier, the Nominal Anchor is not the only reason for seeking exchange rate stability. Second, the experience of Austria and the Netherlands underlines the fact that nominal exchange rate pegs are not necessarily fragile. In both countries, the strength of the peg is assisted by a very close integration with the German economy; in recent years, for example, the inflation pattern in both countries has followed that of Germany more closely than was the case for other countries. However, the long history of following the deutsche mark and the clear disinclination of policymakers to cast doubt in any way on the link have also been critical.

  Third, alternative anchors also suffer from drawbacks. The money supply has long been seen as the principal alternative to the exchange rate as a Nominal Anchor. For many countries in Europe, however, volatility in the velocity of money represents a strong argument against such an approach. Some European countries with strong records of relative price stability—in particular, Germany and Switzerland—have relied on monetary targeting to provide the general orientation to policy. These, however, are seen by many as being special cases, where the long-standing credibility of the monetary authorities has allowed them significant discretion in the implementation of policy. The changes in financial markets related to the ongoing process of market integration in Europe are seen to weaken further the case for monetary targeting, at least at the level of the individual country. It does, however, remain a candidate for the operating framework to be chosen by a future European central bank.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Exchange Rate Politics in Latin America

  • Carol Wise, Riordan Roett, Carol Wise, Riordan Roett(Authors)
  • 2011(Publication Date)
  • Brookings Institution Press

    (Publisher)

  Thus the Nominal Anchor policy must be credible in the labor market. This cred-ibility depends not only on the exchange rate commitment but also on the credibility of monetary policy. Will monetary policy discipline—usually dependent to a great extent on fiscal discipline—actually be attained? The Nominal Anchor approach may not actually involve fixing the exchange rate. There may be a crawling peg. In that case, the rate at which the currency is steadily devalued is predetermined at less than the initial rate of inflation, so that the rate of inflation of tradable goods prices will gradually decline. If wages and prices of nontradables fall at a slower rate, there will be steady real appreciation. At the same time, provided that mon-etary discipline is achieved, the rate of inflation will indeed decline. The advantage of this approach is that it can play a crucial role in reduc-ing inflation. It may play, and often has, the key role in stabilization pro-grams in high inflation countries, as in Argentina, Brazil, and Mexico. The disadvantage is that the costs of failure are high—loss of foreign exchange reserves resulting from lack of monetary and fiscal discipline and unem-ployment and loss of output resulting from real appreciation. The basic premise of the real targets approach is that the nominal exchange rate is varied to achieve real targets, such as attaining the real exchange rate required for higher employment or improvement of the cur-rent account. Implicit in this approach is the idea that a nominal devalua-tion will also bring about a real devaluation. 2 If there is some kind of adverse shock—say, a decline in the terms of trade or a reduction in capital inflow—a real depreciation, leading to improved competitiveness, may be required to improve the current account. In the absence of real depreciation, only a reduction in expenditure, one that would bring about a recession and thus a sufficient decline in imports, can achieve the desired improvement.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Managing Financial Crises : Recent Experience and Lessons for Latin America

  • G. Kincaid, and Charles Collyns(Authors)
  • 2003(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  The major issue that confronted the authorities was how to pursue monetary policy without relying on a single clear and operational Nominal Anchor. Countries can in principle choose to target a money aggregate or inflation. However, countries in this sample rarely followed a money anchor in the aftermath of a crisis. In a context where inflation is impossible to predict with any confidence, money targeting would seem to offer the promise of setting a money target as a clear Nominal Anchor—its achievement assures that there is at least some anchor to the price level. It rarely worked that way in practice, for several reasons:

  • Because of the unpredictability and instability of money demand, monetary aggregate targets rarely served to guide monetary policy execution. Monetary targets were rarely binding, since they were usually widely missed (Mexico) or overachieved (Korea, Thailand, Brazil). These errors were mostly due to surprises in money demand or net international reserves, the latter often the result of large errors in predicting capital flows (Mexico), and did not serve to indicate the adequacy of the monetary stance.13
  • Even if a money target is met, the exchange rate may still be subject to wide swings. These fluctuations, particularly during the panic-prone post-crisis period, risk feeding rapidly into expectations and being validated by balance sheet effects and wage and price-setting dynamics. Monitoring of monetary policy therefore needed to rely on indicators that were observable at high frequencies and bore a direct relationship to market conditions.14
  • The low interest elasticity of money demand in the short run implies that any attempt to strictly control the money supply in the short run tends to result in unbearably high or volatile interest rates (e.g., Turkey, for the first few days after its float). Nonetheless, monetary aggregates can still play a useful supportive role, particularly as objective “trip wires” for cases of egregious failure to conduct an appropriate monetary policy, as has been highlighted by Ghosh and others (2002 ).15

  Sign up to read

  Learn more about book