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

Stan Du Plessis () and Gideon du Rand ()
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Gideon du Rand: Department of Economics, University of Stellenbosch

No 04/2011, Working Papers from Stellenbosch University, Department of Economics

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).

Keywords: Monetary policy; Instrument problem; Interest rates; Alternative monetary policy instruments; Balance sheet operations; Policy co-ordination (search for similar items in EconPapers)
JEL-codes: E52 E58 E61 (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cmp, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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