"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Thursday, May 27, 2010

Michael Woodford - Inflation Targeting during Credit Market Turmoil

Run, don't walk, to read Woodford's BOE presentation "Inflation Targeting during Credit Market Turmoil".

Key takeaways:
  • Central bank policy stance has three independent dimensions:
    • quantity of reserves
    • interest paid on reserves
    • composition of asset side of CB balance sheet (credit easing)
  • Zero lower bound is solved by committing to maintain low interest rates for a time, even after it becomes possible to again achieve inflation target without violating the bound.
  • Price level targeting is essential during credit crisis
    • automatic creation of expectations of reflation
    • it is an inflation targeting regime with commitment to error correction
  • Credit easing may be optimal in the case of large financial disruptions
    • size of credit spreads as a justification for credit policy
    • unrelated to whether zero bound on policy rate reached (ECB in August 2007)
  • Interest on reserves is desirable during credit market turmoil - for credible exit strategy
      Scott Sumner does not agree with Michael Woodford Woodford (and me):
      • Sumner says interest on reserves is a key mistake
      • Sumner says large financial disruptions can be avoided by credible NGDP targeting - no need for CB credit policy
      What I didn't like:
      • Woodford says QE doesn't work when treasuries are purchased and when QE is withdrawn when conditions normalize (see Japan 2001-06). But there is a possibility that Japan would be even worse without such QE 
      • Joint optimality of three dimensions of monetary policy not considered

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