Macro Functions of Central Bank
The Phillips curve model with expectations developed into a short and a long run version. In the short run the trade-off between unemployment and inflation exists, but in the long it doesn’t. According to this model although both monetary and fiscal policy commits to low inflation once private agents enter with expectations the authorities get incentives to deviate with unexpected inflation, causing inflationary bias, that referred to time inconsistency. In the question of output maximization we have to know how unemployment and inflation is connected to output.
Unemployment is tightly related to output: one can say that high employment means automatically high output, and low employment means low output. Output and inflation seems to be positively correlated, but the reasoning is much more complicated. Because of the short run trade off, unexpectedly lower inflation means higher unemployment, so lower output. In the long run this direct proportionality does not work if vertical Phillips curve assumed, economy is in potential output (inflation does not affect output). Read more
Optimal Supervisory Models for Developed and Developing Countries
Financial liberalization, multinationalization of the financial entities, blurring boundaries between various types of financial intermediaries brought about the problem of appropriate regulation of these institutions. The central question that arises is keeping the supervisory function with the central bank or delegating it to the separate independent agency(s). It is important to note that answer to this question may be different for developed and developing countries.
For developed countries the answer is more or less straightforward. First of all separating monetary and supervisory functions in different institutions solves fundamental problem of conflict of interest between two. Moreover, degree of blurring boundaries between various types of financial intermediaries in developing countries is high; therefore separating banking supervision from supervision of the rest of financial sector becomes less feasible. On the other hand, assigning supervision of the entire financial sector to the central bank is also infeasible: first of all it strengthens conflict of interest between two functions even more and second central bank will have to deal with the issues that historically lied outside its scope and expertise. Consequently, for most of the developed countries separating banking supervision from the central bank and delegating it to the unified supervisory entity may be an optimal solution. Read more
Relationship between Hard Ped and Banking Crises
Since 1998 crisis Asian countries have accumulated huge amounts of foreign exchange reserves. Such kind of a “large life jacket” helps to minimize the probability of speculative attacks on currency even under floating exchange rate regimes, makes countries less vulnerable to sudden stops of foreign capital flows and helps to sustain exports by keeping nominal exchange rate of the domestic currency artificially low. This is why many emerging market economies cannot be viewed any more as net exporters of foreign capital, but increasingly the situation changes to the opposite.
Since currencies of many emerging market economies tend to appreciate over time, it would be only natural for domestic borrowers to prefer to borrow in foreign currency and for lenders to lend in domestic currency given credibility of sustainable appreciation path. Therefore, the concept of the “Original Sin” might not be appropriate any longer for many emerging market economies, and this, in turn acts to alleviate the problem of currency and maturity mismatches, thus making bank bankruptcies less likely. Read more
Absolute Advantage versus Comparative Advantage
A country is said to enjoy an absolute advantage over another country in the production of a product if it uses fewer resources to produce that product than the other country does. For example, suppose that country A and country B produce wheat, but that A’s climate is more suited to wheat and its labor is more productive. Country A will therefore produce more wheat per acre than country B and use less labor in growing it and bringing it to market. Country A thus enjoys an absolute advantage over country B in the production of wheat.
A country enjoys a comparative advantage in the production of a good if that good can be produce at lower cost in terms of other goods. Suppose that countries C and D both produce wheat and corn and that C enjoys an absolute advantage in the production of both- that is, C’s climate is better than D’s, and fewer of C’s resources are needed to produce a given quantity of both wheat and corn. Now C and D must each choose between planting land with wheat or corn. To produce more wheat, either country must transfer land from corn production; to produce more corn, either country must transfer land from wheat production. Thus, the cost of wheat in each country can be measured in bushels of corn, and the cost of corn can be measured in bushes of wheat. Read more
