On the (non-)equivalence of capital adequacy and monetary policy: A response to Cechetti and Kohler

Stellenbosch Working Paper Series No. WP04/2011
 
Publication date: 2011
 
Author(s):
[protected email address] (Department of Economics, University of Stellenbosch)
[protected email address] (Department of Economics, University of Stellenbosch)
 
Abstract:

The instrument problem in monetary policy is back on the agenda. Until recently interest rate policy was widely thought to be sufficient for the attainment of appropriate monetary policy goals. No longer. In the wake of the international financial crisis there is much pressure on monetary authorities to incorporate the goal of financial stability more explicitly in policy. This requires an expansion of the instruments typically used by central banks. Cechetti and Kohler (2010) recently considered this new version of the instrument problem in monetary policy by analysing the distinct role and potential for co-ordinating (i) interest rates and (ii) capital adequacy requirements. In this paper we connect this modern debate with an earlier version of the instrument problem, famously discussed by Poole (1970). Then, as now (we claim), the main message of the analysis is the non-equivalence of these instruments and the structural features of the economy on the basis of which one would prefer a particular combination of these instruments. These results are demonstrated with a set of simulations. We also offer a theoretical criticism of the modelling approach used by Cechetti and Kohler (2010).

 
JEL Classification:

E52, E58, E61

Keywords:

Monetary policy, Instrument problem, Interest rates, Alternative monetary policy instruments, Balance sheet operations, Policy co-ordination

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1 March 2021
Even with the release of data showing a record high unemployment rate in 2020Q4, it turned out to be a fairly good week for the SA economy. Daily new COVID-19 infections remained well contained, while the second batch of 80 000 J&J vaccines arrived (albeit controversially with the grounded SAA being the carrier). In addition, relative to the October...

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