Reconsidering the role of nominal monetary policy variables: evidence from four major economies

Abstract

This thesis aims to contribute to monetary policy studies by conducting fundamental research and gathering empirical evidence on the effectiveness of monetary policy in the U.S., U.K., Germany and Japan. The financial crisis in 2007/08 highlighted the weakness of using nominal interest rates as the main monetary policy instrument. Before the financial crisis in 2007/08, the new monetary consensus (Bernanke 1992, 1995, and 1996, Woodford, 2003) that interest rates could be the effective intermediate instrument to influence the economy was widely accepted by central banks. It had developed since the failure of monetarism in the late 1970s. Some central banks (BOE, ECB, and RBNZ) have adopted specific inflation targeting, and approach it through the short-term interest rate. However, as the short-term interest rate has approached zero in a number of countries, it has become apparent that new monetary policy instruments are needed. Quantitative variables (including measures of money and credit) have since become of greater concern again, especially since a policy of “quantitative easing (QE)” was adopted by the Bank of England in 2009.
The main goal of this research is to provide empirical evidence on the interaction between financial variables (interest rates, money and credit) and economic variables (nominal GDP). Three main questions are being dealt with:
(1)Are financial variables (interest rates, money and credit) appropriate to target nominal GDP?
(2)Do quantitative variables (money and credit) have superior predictive abilities to the price variable (interest rate) in predicting nominal GDP?
(3)Do credit variables perform better than money aggregates in explaining nominal GDP?
The empirical analysis employs simple regressions, Granger causality tests, the general-to-specific modelling methodology and VARs model. The empirical results suggest that quantitative variables (money aggregates and GDP-circulation credit) have more predictive power for nominal GDP than price variables (interest rates). Meanwhile the GDP-circulation credit displays more accurate features than money aggregates to target nominal GDP. Overall the outcomes not only enrich the literature regarding the monetary policy in the U.S., U.K., Germany and Japan but also provide further empirical support for a modified ‘credit view’ of the transmission of monetary policy. They also have implications for the design of a successful monetary policy implementation regime

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