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207
УДК: 338.001.36
Liakhova D.S.
Saint Petersburg State University DOI: 10.24411/2520-6990-2020-11674 DEVELOPMENT OF MONETARY POLICY ROLE IN FINANCIAL CRISIS
Abstract
Monetary policy provided by governments in world crisis periods had a sufficient role for international economy. In the paper there are considered specific features of monetary authorities' regulation applied to first, second, third generation crisis models, subprime crisis and the current economic crisis connected with the COVID-19 emergency. The article provides the list of arguments why monetary policy could be reasonable or not in dependence of various economic problems.
Key words: First, second, third generation crisis models, subprime crisis, COVID-19
Monetary policy is a strong tool of governments that is widely used during crisis periods in countries. The policy is usually applied by Central Banks or other competent monetary authorities by controlling the quantity of money markets possess and other influencing economic instruments (interest rate, reserves, the level of inflation, liquidity). The measures complied by monetary authorities involve influence on interest rate, buying bonds, regulating foreign exchange rate and the minimum level of banks' reservation.
The efficiency of monetary policy depends on the exchange rate regime conducted in a country. Under flexible exchange rate monetary authorities can achieve equilibrium in national economy, but monetary policy seems to be unsuccessful under fixed exchange rate. Monetary policy is effective with a flexible exchange rate regime, as it helps to improve national economy by increase in output: expansionary policy creates a money supply higher that money demand that leads to interest rate decrease, as a result - nominal exchange rate rises and it makes national export more competitive. So as a country's export (as a part of domestic output) grows sequentially output grows. With a fixed rate regime in a country monetary policy is not absolutely effective, as it just ends in comeback to the lower level of money supply: when the government needs to defend the fixed exchange rate it is necessary to reduce reserves and then - drop money supply. More than that, monetary policy is effectively used to overcome cyclical disturbances economic disorders, but in case of abuse it leads to inflation. Monetary policy is targeted on stimulating domestic output through effects of exchange rate depreciation.
In First Generation Models of currency crisis, considered by Flood and Krugman the nature of Monetary Policy became a reason of the crisis: there was an incompatibility between using monetary policy and the tries to keep a fixed exchange rate and the way authorities used monetary instruments caused a high public deficit. During speculative attacks on a fixed exchange rate (when speculators were willing to buy foreign currency and sell the domestic one) the money supply decline was equal to the size of this speculative attack. Money demand was also reduced because of the growth of domestic interest rate. To save the fixed exchange rate regime the government had to keep money supply fixed and introduce expansionary policy with reduction of reserves. The more speculative attacks happened the
less reserves left in government possession. Once the reserved had been on the zero-level, the fixed exchange rate regime was abandoned. Authorities didn't use policies when money stock was weak as there were not too much threats for the internal economic situation. Appreciation made by the monetary authorities in the situation of full credibility was more probable and by speculators' interventions (buying domestic and selling foreign currency) the peg was stabilized. In a long-run period no one amount of reserves was sufficient to keep fixed exchange rate, so monetary policy turned out to be ineffective in this model of crisis.
In the Second Generation Model the crises occurs from a conflict between fixed exchange rate regime and expansionary monetary policy that influences on a change of interest rate (that increases). Government has a non-linear behavior and is possible to have no one, but multiply equilibria by monetary policy tools as well. Here government policies are not always credible as they prefer to reduce losses that to keep fixed exchange rate. So they choose and optimal depreciation of domestic currency. To raise output monetary authorities apply 'surprise' depreciation (inflation) - systematic inflation bias, that appear from government's effort to reach the optimal point (intersection of Phillip's curve and E curve) by predictable nominal wages. To decide which regime to choose (fixed ore flexible ex. rate) government compares losses. The monetary authorities' goal was devoted to output stimulation (above the natural level) and keeping inflation (those were described by Barro and Gordon). In a multiply period by applying these two conditions together the government can face even higher inflation as a sequence.
Third Generation Model describes twin crises happened in Asia in 1997. Because of the increase in output (that happened in quickly and highly developing Asian countries) money demand started to grow and by expansionary monetary policy authorities got the decrease of domestic interest rate and then - depreciation of a local currency. During the crisis the recommendations in International Monetary Fund was to raise domestic interest rate by decrease in money supply (restrictive policy). This was supposed to help to eliminate the currency crisis and bring a growth of output. However, this sequence isn't always relevant. So it is believed that the better way is to get a lower interest rate by monetary expansion. Monetary authorities while making choice between restrictive or expansionary policy rely on the
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proportion of domestic/foreign debt and sensitivity of credit supply. If foreign debt is much higher and sensitivity - small, it is better to make a restriction and up the interest rate, on the other hand with a high level of domestic debt that much exceeds foreign debt government should better introduce expansion policy and reduce interest rate. Authorities could also consider the proportional multiplicator between the maximum amount of borrowings and cash flow of entrepreneurs: the higher is the index, the better financial development in a country and more likely to use monetary expansion. In overall monetary policy in the third generation model can be beneficial only if the economic situation in a country isn't strongly negative.
Subprime crisis (that happened in US in the mis-2000's), as can be supposed, was created by monetary policy introduced by the government before to stabilize economy - keeping interest rate on an extremely low level. Monetary authorities used to underestimate the existence of a bubble in a mortgage market, taking care at the last moment before which the financial sector was almost without regulating. Because of a high inflation the interest rate responded to it by increase. Monetary authorities had to take care of the impulses made by banking sector. However, government could use only interest rate tools, trying to keep it appropriate low in a long-run, but it's not correct possible to proceed infinitely, so the managing with the crisis situation was almost fault. The classical tool to recover from this 'default' is providing by Central Bank a massive amount of liquidity to the banks. Also Central Bank can cut interest rates for the period of crisis (till the economy recovery) to let commercial banks to increase profits and reduce benchmarks to reset. At the moment of full recovery Central bank should stop donating' liquidity and reclaim the previous interest rate. The instrument of crisis regulation could also include the commercial banks net savings restrictions as a minimum % of assets. How did US government reacted to the crisis and which monetary measures undertake to smooth the damage? Firstly, it was tending to keep a low interest rate in a long-run period to encourage economic activity. The authorities also used the quantitative easing tool: they purchased long-term securities from the private sector.
The latest situation with a COVID-19 disrupted economies all over the world. Authorities from different countries conducting various policy tools including monetary policy. Thus, the European Central Bank and US Federal Reserve limited the benchmark interest rate till around zero-level (0,25 in US and 0 in EU). This, as policy-makers believe, should encourage people to buy
and borrow more. Central Banks are also using the method of quantitative easing - buying bonds from commercial banks and individuals to pump money into economies - securities purchases. Many strong monetary policies were introduced in USA: widen loans to ensure security for firms, banks, corporate employers with the lowest interest rate; making US dollars more available for foreign central banks. These helps to avoid the crisis crush situation brought by previous policies. For Italy there were invented some supporting measures from European Central Bank: they promise to purchase assets and provide additional auctions of the full-allotment, more attractive standards on existing targeted longer-term refinancing operations in Euro system. The Italian government claimed a moratorium on loan repayments for some households. The ECB terms were also spread on other European countries suffered from the COVID-19 pandemic. The People's Bank of China, for example, accepted liquidity infusion into the national banking system and expansion of re-lending and re-discounting facilities - all by liquidity support of small and medium sized firms. Some negatively affected households and companies got the opportunity of loan payment delay. It's worth saying, some countries, although, didn't attached monetary policy tools during the approaching economic crisis: for example, Russian authorities strongly believe that the most favorable policies in the modern economic situation are fiscal ones, as monetary tools have more indirect effect and don't get the population directly.
We should remember that monetary policy makes a successful effect on economy only in a short period, while in a long run in will bring back to the initial level (of output). As we could notice monetary policy is not definitely effective in managing crisis situation in economy.
References:
1. Financial Crisis in East Asia: Bank Runs, Asset Bubbles and Antidotes Marcus Miller and Pongsak Luangaram / CSGR working Paper No. 11/98, July 1998. - p. 12-43
2. Paul R. Krugman. Target Zones and Exchange Rate Dynamics / The Quarterly Journal of Economics, Vol. 106, No. 3. (Aug., 1991) - pp. 669-682
3. Philippe Aghion , Philippe Bacchetta *, Abhi-jit Baneijee. A simple model of monetary policy and currency crises / European Economic Review 44 (2000) - p. 728-738
4. International Monetary Fund: Policy responses to COVID-19 / https://www.imf.org/en/Top-ics/imf-and-covid19/Policy-Responses-to-COVID-19#I (03.04.2020)
