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Archive for the ‘Money rules’ Category

Did you know that central banks have not always been State-owned banks? The vast majority of them were in the hands of the public before the wave of nationalisations that took place right after the end of WWII. And the system did not work bad at all; the record of both price stability and financial stability before 1913 was certainly impressive. True, bank panics also occurred but the different response taken to such crises is the key to understand the pros of a monetary system fully in the hands of the public and market participants. And, a regards price stability, from approx. 1870 to 1913 most developed (and other less developed) economies ran the gold standard as the rule to determine the amount of money in the economy; a standard which very much tied the hands of central banks and governments as regards money creation. The outcome of the running of a system which preserved monetary stability for a 50 year-time period limited was (not surprisingly for any monetary economist!) was true price stability (by true, I mean that the price level in 1870 was roughly similar to that in 1913), and a growing and rather stable financial system on the whole.

Why was such a ‘miracle’ possible? There is no mystery nor secrecy about it at all! It was the establishment of the right institutions and policies to discipline both the Treasury and a highly independent (actually privately-owned!) central bank what explains such a favourable outcome. And, did you know something even more striking? Several central banks are traded in the market in our days in different ways: the Swiss National Bank, Belgium Central Bank, Reserve Bank of South Africa, Greece Central Bank and Bank of Japan. Historically speaking as I said above this is not an anomaly but the norm before the 1940s. Given the poor record of our monetary authorities since then and the miss-management of the recent financial crisis, why not extending private ownership even further and thus mitigate the threats of a politically-exposed (some will say ultimately ‘controlled’) central bank?

In an interview with Standard and Poor’s, ‘New way forward or outdated anomaly? The future of publicly traded central banks’ (S&P Global. Market Intelligence), I advocate for central banks to return to the public and the banking sector, in order to guarantee their independence from governments and thus be able to achieve a more sound and stable monetary system. You will find the arguments in favour of a more independent central banks, owned by market participants in many references. Here I will just mention two of them, one written by Tim Congdon (Chairman of the Institute of International Monetary Research), Central Banking in a Free Society (IEA), and the other by myself with Pedro Schwartz (Visiting Professor, University of Buckingham), Central banks; from politically dependent to market-independent institutions (Journal of Economic Affairs); both pieces written in the midst of the Global Financial Crisis (2008-09) and the observed mismanagement of the lender of last resort function of central banks.

Find below an extract from the interview with my arguments:

‘Those in favor of privately owned central banks say such institutions would be better equipped to preserve market stability and could help prevent future financial crises.

“If publicly traded or owned by the banking sector … the market incumbents will have a genuine interest in setting clear … rules for the central bank to maintain financial stability over the long term,” said Juan Castañeda, director of the Institute of International Monetary Research at the University of Buckingham in England.

In the event of another financial crisis, a central bank would be fully independent to intervene at a bank in need, and any injection of capital would come from the banking or private sector, Castañeda said. Situations like the nationalization of Northern Rock by the Bank of England at the outset of the global financial crisis could be averted were central banks not in public hands, he argued.

“Those are the things that you can avoid if your central bank is publicly traded,” he said, citing the late 19th century example of U.K.-based Barings Bank, which faced bankruptcy but was saved by a consortium of fellow lenders, helping to stave off a larger crisis.

Oversight of a central bank would belong to the bank’s shareholders, although national authorities would also have a say because of the bank’s management of monetary policy and financial stability.’

It is not surprising Tim Congdon and myself advocate for more independent central banks (privately-owned) as a way to protect them from political interference in the development of its functions. I do believe this would contribute to a more sound running of monetary policy and to less financial instability in the future. If publicly-traded or owned by the banking sector (following the US Fed model), market incumbents will have a genuine interest in setting clear mandates/rules for the central bank to maintain financial stability over the long term. Should another financial crisis occur in the future (that it will), the central bank will have free hands to intervene promptly and avoid the contagion of panic in the market (by the application of its lender of last resort function). And if any injections of capital were needed, it would be the banking sector (or the private sector as a whole) which would bail-in the bank in crisis and, most likely, taxpayers’ money will not be needed again.

Of course this alternative arrangement is fully compatible with the central bank be given statutory functions (such as an inflation target for example) and be subject to parliamentary oversee; so the Governor will have to answer not just to the Bank’s shareholders but to Parliament as well in relation to the running of monetary policy and financial stability (find further details on these arrangements in Congdon’s 2009 work mentioned above).

Juan Castañeda

PS. An excellent narrative of the flaws of the current system can be found in Milne and Wood (2008)’s  analysis of Northern Rock bank crisis in the UK.

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Monetary economics is in shambles. More than eight years after the outbreak of the Global Financial Crisis  many things in our economies have changed indeed, particularly the range of operations in which central banks have embarked in the last few years; but the way mainstream academia and policy makers understand and approach monetary economics have not. The old policy rules which contributed so much to the building up of monetary instability and finally to a profound financial crisis have not really been questioned nor replaced yet by a consistent set of new policies (or better, a policy rule) committed to maintaining monetary stability over the medium and long term. Even worse, I have attended myself scientific meetings on this field in the last years and very rarely (if at all) ‘money’ or ‘monetary aggregates’ are even mentioned in (supposedly) specialised monetary talks and lectures. Instead we seem to be stuck in endless discussions on interest rates and how a 0.25 increase/decrease in the policy rate may affect consumption, investment and eventually output by the spending and credit channels; for the initiated in this subject this means we still use the late 1990s and early 2000s’ new Keynesian model (with no money) to analyse and prescribe monetary policies.

Well there are indeed notable exceptions to the mainstream, and I am very pleased to invite you all to the 2016 monetary Public Lecture of the Institute of International Monetary Research (IIMR), by professor Charles Goodhart. One of the main purposes of the Institute is to promote research into how developments in banking and finance affect the economy as a whole. The Institute’s wider aims are to enhance economic knowledge and understanding, and to seek price stability, steady economic growth and high employment. Particular attention is paid to the effect of changes in the quantity of money on inflation and deflation, and on boom and bust.

Banks and central banks play a central role in the sound functioning of modern monetary economies. The 2008-09 Global Financial Crisis has shown again how important it is to understand their functioning and operations, and the relationship between the quantity of money and the overall economy.

We have much pleasure in inviting you to join us at the Institute’s 2016 public lecture on Wednesday 2nd November (18:30 hrs.) by Professor Charles Goodhart (LSE): ‘What have we learned about money and banking during and since the Great Recession?’, at the Institute of Directors (116 Pall Mall, London).

You may want to visit our website to learn more about the Institute’s research agenda and our latest publications on our website (http://www.mv-pt.org/index). You may want to know the public lecture will be recorded and available on our site.

Thank you,

Juan C.

PS. Please confirm your attendance by e-mail to Gail Grimston at gail.grimston@buckingham.ac.uk

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Selgin on deflation(s)

Professor G. Selgin (University of Georgia and Cato) has masterly studied the question of deflations and distinguished those benign deflations, associated with increasing productivity and economic growth, from those recessive deflations associated with stagnation in the economy, increasing unemployment and financial instability, which seems to be the only one mostly considered by all and sundry. As Hayek did it in the 20s and 30s last century, Selgin has studied in detailed this question and has emphasised the notable implications of distinguishing amongst these different types of deflations in the running of a sound monetary policy rule (see his excellent Less than zero. The case for a falling price level in a growing economy, fully available at the IEA website).

One of the main implications of his analysis of deflations for policy making is that price stabilisation (either the price level or the inflation rate) is not a desirable policy criterion if we are committed to achieving monetary stability in the long term: it can lead to excessive money growth in the expansions of the economy (thus, monetary disequilibrium), being a major pro-cyclical policy that will destabilise financial markets in the medium to the long term. Other, both theoretical and operational, critiques to price stability as a policy criterion can be found here. This is by far the main lesson that can be drawn for the recent financial crisis and its precedent years, and it will a be very useful one if we do not want to resume the same policy rules that have contributed to the recent crisis and the monetary and financial chaos in which we are still in.

Enjoy George Selgin’s video, which is a recent CNBC interview; it is an excellent and brief explanation on the nature and consequences of different  deflations: http://video.cnbc.com/gallery/?video=3000171632

Juan Castañeda

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Mr. Carney, the Old Lady is not for tying

I found this caricature in The Times last Saturday (see below) and I could not resist the temptation to write a post on it. With a blog like this one, with its name, I had no other choice but to welcome and echo this caricature and its message. As I already explained in more detail here, I do believe that a  course on money and central banking could be taught by using these classical (and contemporary) caricatures as the main material of the course. They provide the political and historical context needed to properly analyse how different constraints/events have affected the policies conducted by the central banks along the modern history.

As J. Gillray masterly did it two centuries ago, here you will find again the (poor) Old Lady screaming and fighting with the authorities; represented this time not by the prime minister but by the next governor of the Bank of England, Mr. Carney. There are some other differences of course. In this new version of Gillray’s “Political-ravishment, or the old lady of Treadneedle-Street in danger!” (1797), the new governor is not taking some gold coins from her pocket but trying to keep the Lady well tied up and under his control. The Lady is obviously protesting and is struggling to free herself from the new ties imposed in the last years; ties which represent the new and extraordinary lending facilities the Bank has had to implement since the outbreak of the recent financial crisis to assist the banking system and the Government. True, many will say that the central banks, wisely acting as the lenders of last resort of the financial system, had no other alternative but to support the banking system and maintain the proper running of the payment system. Fine, I agree to some extent since, in the face of a major financial panic, the central bank must act firmly and timely to avoid the collapse of the financial system. But at some point these extraordinary policies will have to cease and the central banks will return gradually to normality in the coming years; which certainly will mean the adoption of a more orthodox monetary policy, one committed to maintaining the stability of the financial system but also the purchasing power of the currency. Let’s see if the new governor of the Bank of England succeeds and is able to extend the existing “ties” or even adopt new ones: an expansionary nominal income targeting strategy?, the adoption of a new, higher of course, inflation target?

Nothing new at all. Under the gold standard there were clear rules which prevented the central banks from printing too much money. In our days, under a fully fiat monetary system, one in which money is created out of thin air (or ex novo), those rules are even much more needed (though become blurred many times …); so, yes, somebody must tie the hands of the Government and those of its bank (i.e. the national central bank) not to overspend and overissue respectively, in order to maintain monetary stability and the purchasing power of the currency in the medium to the long term. Until relatively recently (in the interwar years), it was in the very nature of the central bank to limit the amount of money in circulation to preserve the value of its own currency in the markets. It was a profit maximising institution for quite a long time and that was the best policy to increase the demand of its money and thus its revenues (the seigniorage). However, as depicted in this caricature, this time it looks like the world is turning upside down, since it is the (next) governor of the Bank of England, the “manager” of the bank, the one who wants to impose his own (new) ties to the Old Lady to keep on running extraordinary policy measures in the UK.

Future will tell which vision prevails in the UK and elsewhere, the classical one which defines the central bank as a bank which provides essential financial services to the banking system (a sound money amongst them) or the modern view of the central bank as a major policy actor committed to a time changing basket of macroeconomic goals, either given by the government or not.

Paraphrasing Mrs. Thatcher’s very famous quote (1980), The Time‘s cartoonist has chosen a very clever title for this satirical caricature: “the Lady is not for tying (see below). Enjoy it.

Juan Castañeda

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Published in The Times, 4th May 2013. Business section p. 51. “The Lady’s not for tying”. By CD, after Gillray.

After_Gilray_TheTimes2013

 

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A market solution for the Euro crisis

This month the Institute of Economic Affairs (London) has published a new book with a collection of essays of different authors on the crisis of the euro, edited by Philip Booth: “The Euro- the beginning, the middle … and the end?“. In these troubled times, dominated by those who only see more fiscal centralisation as the single way to overcome the euro crisis, this book is a true rarity; as, amongst others, it has several chapters with practical proposals to foster the introduction of more monetary competition to address and finally tackle some of the major problems affecting the European Monetary Union. And yes, I said “practical” proposals because, some of the chapters of the book do contain not only a description of the benefits of having more monetary competition in order to achieve more monetary stability in the medium to the long run, but also the institutional and market arrangements needed to be implemented in the current scenario in Europe.  A novelty indeed! In this regard, the proposal I support in the book (chapter 6), which consist of (1) at least the elimination of the legal tender clause and (2) the competition of the euro with the former national currencies, could be just a starting point in the right direction. Even more, we (profs. Schwartz, Cabrillo and myself) have calculated the costs of this alternative (more open) monetary regime and they are by far less than the costs we are all still paying just to maintain the current (flawed) system.

The publication of the book (12th April) was accompanied by the following (joint) statement of the contributing authors (see their names and  affiliations here):

“The euro zone as we know it must end or be radically reformed. Current mechanisms being used to manage the euro crisis are inadequate at every level. And as Cyprus shows us, the euro-zone crisis is far from over.
In new research from the Institute of Economic Affairs, The Euro: The Beginning, the Middle … and the End?, leading economists in this field, analyse the problems with the current approach being taken to resolve the euro zone crisis and argue:
  • Product and labour markets in euro-zone member states are far too rigid to respond adequately to economic shocks. The result has been high unemployment and prolonged recession in a number of euro-zone countries.
  • The EU must therefore face up to the inadequacies of its policies both in terms of the long-term structural errors in policy and of the short-term management of the euro-zone crisis.
  • There should not be a debt union of any form. Governments must be responsible for servicing their debts without bailouts.
  • Euro-zone countries must deregulate their labour markets and reduce government spending. Decentralisation and the promotion of a market economy must be at the heart of EU policy.
The report outlines several options for radical reform of monetary arrangements within the euro zone, including:
  • A complete and orderly break-up of the euro and a return to national currencies combined with the vigorous pursuit of free trade policies.
  • The suspension of Greece, and possibly other failing euro members, from all the decision-making mechanisms of the euro. These countries could then re-establish their own national currency to run in parallel with the euro. Both would be legal tender currencies with free exchange rates. Such an approach should be part of a more general agenda for decentralisation in the EU. This proposal mirrors the “hard ecu” proposal of the UK government before the euro was adopted as a single currency.
  • The enforcement of strict rules relating to government borrowing and debt that all member countries would have to meet. Member countries who did not obey the rules would not be able to take part in the decision-making mechanisms of the ECB. Furthermore, the ECB should play no part in underpinning the government debt of member countries.
  • A system of liberalised free-banking within which businesses and individuals choose the currency they wish to use.”

You can find more details on the book (and the full book free online) here, at the IEA website. The book will be presented at the IEA on the 9th of May (18:30); see more details here if you wish to attend.

I hope you find it interesting to promote the discussion on these important issues. All comments on our proposal on parallel currencies for the Euro zone will be very welcome.

Juan Castañeda

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 “Los Bancos Centrales deben hacer menos, no más”

Este es el acertado titular con que el periodista especializado en economía, Diego Sánchez de la Cruz, resume nuestra entrevista, que acaba de publicarse en Libre Mercado (10/3/2013). En un tiempo en que parece que todos piden al banco central que haga más, como si fuera una especie de Deus ex Machina  omnipotente capaz de sacarnos de la crisis y parálisis económica actuales, merece la pena recordar que fue precisamente el activismo y excesivo crecimiento monetario desarrollado en la última expansión económica lo que está en la base de los problemas que aún padecemos. Por eso, una vez solventada la crisis financiera (cuando quiera que ésto sea), convendría reflexionar sobre cuál es la mejor política monetaria para la nueva etapa expansiva que, en mi opinión, pasará por una reforma en profundidad de las reglas monetarias vigentes hasta 2007. Una política monetaria que sea menos activa y se centre en la estabilidad monetaria y no en el manejo de la economía, el control del ciclo (del “output gap”) ni tampoco la estabilización de los precios, menos aún si se hace persiguiendo un crecimiento (aunque sea moderado) de la inflación medida mediante el IPC.

Hablamos también de los recientes rescates bancarios, la política de préstamo (más o menos expreso)  de los bancos centrales a sus Estados, así  como de algunas alternativas al sistema actual de monopolio de emisión de moneda de curso legal controlado en última instancia por el Estado. Como siempre, vuestros comentarios serán muy bienvenidos en el blog.

Texto completo de la entrevista aquí:

http://www.libremercado.com/2013-03-10/juan-castaneda-los-bancos-centrales-deben-hacer-menos-no-mas-1276484372/

Juan Castañeda

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(A summary in English)

“Central banks should do less, not more”

This is the headline of my recent interwiew with the economic journalist, Diego Sánchez de la Cruz, just published in Libre Mercado (10/03/2013). In a time when all and sundry ask the central bank to do more, as if it were an omnipotent “Deus ex Machina”  able to overcome the current economic and financial crisis, it is worth remembering that it was central banks’ monetary activism and excessive money creation during the last economic expansion what ultimately caused a massive distortion in financial markets and led to the current crisis. As recessions and crises have its roots in the previous expansion, we should be discussing now which is the best monetary policy to be adopted in the next expansionary phase of the cycle (see here a summary of the debate in the UK). One less active and more focused on maintaining monetary stability and not the management of the economy, the stabilisation of the cycle (the “output gap”) or price stabilisation, let alone the stabilisation of a positive inflation target as measured by CPI.

We also discussed in the interview other “policies” of the central banks, such as the recent banks’ bailouts and the more or less explicit financial assistance to the(ir) States; finally, we also talk about some alternatives to the current monetary system ultimately controlled by the State. As always, your comments are very welcome.

Full access to the interview here:

http://www.libremercado.com/2013-03-10/juan-castaneda-los-bancos-centrales-deben-hacer-menos-no-mas-1276484372/

Juan Castañeda

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Monetary stability is what matters Mr. Carney

Quite a lot is being said and written recently on nominal income targeting. Mr. Carney, the new elected governor of the Bank of England, has had a primary role in it. Even though there has been a debate amongst academics and central banks’ analysts for quite a long time, his recent suggestion in a public speech (see here) of a nominal income rule for the conduction of monetary policy by the Bank of England has been the true milestone that have triggered the debate on monetary policy strategies across the world, and particularly in the UK. Almost everyday many commentators and columnists are analysing this question in prestigious and influential business papers such as Financial Times or The Economist. This is not surprising at all, as nominal income targeting is presented as an alternative to inflation targeting, the monetary strategy framework used de facto or officially by most central banks during the last business cycle expansion, the years of the so-called Great Moderation.

This debate is needed and essential for the conduction of a more stable monetary policy in the near future, but we should analyse in more detail what is being exactly proposed and for which purposes.

Just a transitory solution?

First of all, it is important to remember that Mr. Carney suggested the adoption of a nominal income rule as a new (and more flexible) policy framework to provide even further monetary stimulus to the economy. And, in particular, he has suggested a nominal GDP level target. However, following his own words, it can be interpreted as just a transitory policy proposal to allow the central banks the injection of more money in the economy. This is confirmed by the tone of the comments/articles published on his proposal, which evidenced a warm welcome by all and sundry. Just see below the reaction of The Economist  (“Shake´em up Mr Carney”) last week as an example, even suggesting a nominal GDP rate of growth target to be adopted by the Bank of England:

“That is where the nominal GDP target comes in. By promising to keep monetary conditions loose until nominal GDP has risen by 10%, the Bank would provide certainty that interest rates will stay low even as the economy recovers. That will encourage investment and spending. At the same time an explicit target of 10% would set a limit to the looseness, preventing people’s expectations for inflation becoming permanently unhinged. It is an approach similar in spirit to the Federal Reserve’s recent commitment not to raise interest rates until America’s unemployment rate falls below 6.5%”.

Following this article, there is no doubt that this strategy is taken as a mere temporary solution, just for the current (very much extraordinary) time:

“The last problem is Mr Osborne. A temporary nominal-GDP target needs his explicit support. He should give it, because against a background of tight fiscal policy, monetary policy is the best macroeconomic lever that Britain has”.

So are we just discussing about a temporary solution for an extraordinary scenario or are we proposing a permanent change of the monetary strategy followed by the Bank of England since 1998? The test to evaluate the true commitment of central banks to a more reliable and stable monetary policy rule will come when the economy enters into a new expansionary phase in the near future. At that time, a nominal income rule committed to monetary stability will prevent money and credit from growing as much as they both did in the past; so it will become much harder to follow it. We will see then how committed central bankers, academics and market analysts are to the conduct of this monetary rule.

Not a single but many nominal income rules

Secondly, there is no a single nominal income rule. Many considerations matter in its operational definition: it could be adopted either in terms of nominal GDP levels or in rates of growth; if just current indicators or alternatively expected variables enter into the decision-making process, it could be either a backward or a forward-looking rule; depending on the ability given to the central bank to react to (registered or expected) deviations from the target, it could be a passive (or non-reactive) or an active rule; the selection of the inflation and GDP growth targets obviously matter a lot, … . So, as some of their critics suggest, I agree that they could be used by central banks to inflate the markets in an attempt to manage again aggregate demand and real variables (see some on the critics here; made by a true expert in monetary economics, professor Goodhart). However, I do not agree with the critics on their entire dismissal of these rules, as they do not  have to be necessarily inflationary and destabilising monetary rules at all; quite the contrary!

You can find more detailed explanations on nominal income targeting and the reply to its most common critics in two excellent blogs on monetary economics: Scott Sumner´s The money illusion and Lars Christensen´s The market monetarist. I wrote a brief article on these rules in 2005 for the Journal of the Institute of Economic Affairs: “Towards a more neutral monetary policy: proposal of a nominal income rule”. As you will see there, I proposed a nominal income rule committed to maintaining monetary stability and not price stability; one by which (broad) money supply grows at the expected  rate of growth of the economy in the long term, and at the same time allowing prices to fall. As evidenced in a more recent paper written with professor G. Wood (see the full version here), its application would have led to much lower rates of growth of money during the last expansion of the economy and, on the other hand, it can be said that it would have avoided the sudden collapse in money growth since 2008. In sum, it would have provided both a (1) less inflationary and (2) more stable rate of growth of money.

Leaving the details (some very important indeed) aside, I do support a permanent change in the monetary policy strategy of central banks. It is time to abandon inflation stabilising rules that, as it is evident for almost all now, have not led to monetary nor financial stability.

A solid theoretical background: monetary stability rather than price stability

There has been a long debate and controversy amongst the supporters and critics of price stabilisation as a criterion for the running of monetary policy (2). F. A. Hayek masterly stated in the 20s and 30s how inflationary the application of that policy criterion could be in the presence of growing economies. As he explained, those central banks committed to maintaining price stability have to inject more money into the markets just to offset the (benign) deflationary pressures accompanying the expansion of the economy; which leads to a rapid (and unsustainable) growth of money and credit that finally distorts financial and real markets (the so-called “boom and bust” business cycle theory). However, since the end of WWII, and after three decades of fine tuning monetary policies and central banks subject to the financial needs of a growing State, the proposal and adoption of (low though positive) inflation targets since the late 70s was received as a blessing by mostly all; especially by the academia, who had been claiming long ago for a more consistent policy rule committed to price stability in the medium to the long run.

The american economist George Selgin followed Hayek´s lead and proposed in his excellent 1997´s “Less than zero. The case for a falling price level in a growing economy” (entirely available at the IEA´s site) what he called a “productivity norm”; which, in a nutshell, allowed for some (mild and benign) deflation when productivity and the supply of real goods and services are growing.

A discussion on monetary policy rules is essential to avoid some of the (monetary) mistakes made during the last expansion of the business cycle. We have already seen how the adoption of price stability as a policy target, or worse (CPI) inflation targeting rules, do not necessarily contribute to financial stability in the medium to the long run. J. A. Aguirre and I have proposed recently (see more details on our book here) another policy rule; one committed to monetary stability that prescribes money growth in line with the real growth of the economy in the long run, and allows for disinflation and even mild deflation when productivity growth increases the output of goods and services in the economy. Nominal income targeting may well be a (only one of them) way to implement it.

We have been waiting for a debate on this question for quite a long time and is indeed very much welcome.

Juan Castañeda

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(1) However, both in the oral and written evidence provided to the UK Parliament´s Treasury select committee this week Mr. Carney was much more conservative, and in fact supported the current “flexible inflation targeting” strategy of the Bank of England.

(2) As to the critique on price stabilisation rules, see some of my previous entries to the blog:

“Central banks price stabilisation rules creates inflation”

– An a paper I wrote with Pedro Schwartz on this question: “Price stability does not always lead to monetary stability nor to financial stability” 

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