Rethinking Monetary Policy: Towards Higher Inflation Expectations in the Aftermath of the Global Financial Crisis

by Tuukka Taipale

Institution: University of Helsinki
Year: 2015
Keywords: Taloustiede
Record ID: 1136248
Full text PDF: http://hdl.handle.net/10138/153574


Abstract This thesis rethinks monetary policy dividing time into two review-contexts in relation to the recent global financial crisis. The thesis leans on three different theoretical and quantitative models which are applied in order to examine a central bank's possibilities to control or affect inflation. The first review-context covers time from post-WWII to the end of the period of Great Moderation, which preceded the crisis. The second review-context covers time from the eruption of the crisis in 2008 to the current day. The thesis is motivated by several questions. First of all, the thesis aims to examine the fundamental differences in monetary policy between the pre and the post-crisis periods, i.e. to examine the differences between conventional and unconventional monetary policies. Secondly, the thesis attempts to examine what possibilities are available to a central bank in controlling inflation in different schemes and within both contexts. Thirdly, as the inflation rate is persistently low in the eurozone this thesis endeavors to explain and provide suggestions to create higher inflation expectations and potential options to escape a liquidity trap situation. In the pre-crisis context it was found that the coordination of monetary and fiscal policies play a key role considering a central bank's possibilities to control or affect inflation. It was also found, whitin another model, that a central bank is able to control inflation (and expectations) by choosing and credibly following a policy rule. With the examination of the central and commercial banks' balance sheets and credit creation it was observed that deposits and reserves have a crucial role in the monetary system. In the post-crisis context it was found that, even if the zero lower bound on the nominal interest rate is binding and further causing conventional open market operations to be ineffective, the central bank may stimulate the economy via quantitative easing. By these unconventional open market operations the central bank extends credit to the economy, provides more liquid assets to the private sector in the form of reserves and government debt, and is able to show commitment to change to another monetary policy rule that is associated with higher inflation expectations. Evidence from the swap market data was found to support the claim that long-term asset purchases and thereby expanded central bank balance sheets succeeded in increasing inflation expectations in the USA and in the UK in the midst of the crisis. The thesis introduces also an unwelcome liquidity trap situation in monetary policy, where the nominal interest rate hits the (zero) lower bound and cannot be lowered further. Potential solutions to escape the trap are discussed. Tiivistelmä Tutkielma tarkastelee rahapolitiikkaa globaalin finanssikriisin jälkimainingeissa jakaen ajan kahteen eri tarkastelujaksoon. Tutkielma nojaa kolmeen eri teoreettiseen ja kvantitatiiviseen malliin, joita sovelletaan pyrittäessä tutkimaan keskuspankin mahdollisuuksia kontrolloida…