Saturday, April 25, 2009

Central Bank credibility in the united states and japan

Since WORLD war 11,the U.S.federal reserve system frequently stated an anti-inflation policy.During the second half of the 1970s,when inflation rose steadily,the credibility of the fed,s promise to fight inflation eroded in October 1979,the fed announced that it would focus on targets for the growth rates of monetary aggregates and that target ranges would be reduced significantly to reduce inflation.
The fed experienced difficulty in achieving its targets,owing in part to deregulation and the wave of financial innovation in the early 1980s. The fed,s announced intention to combat inflation indeed succeeded over time.inflation fell from double-digit levels in 1979 to about 4%per year by 1982 and has remained relatively low since then. In part because of the fed,s lack of credibility at that time,disinflation was not without cost,however. In response to the contractionary monetary policy initiated in late 1979,output and employment declined and real interest rates increased. The economy experienced a severe recession in 1981 and 1982.
Because Japan relied wholly on imported oil,the oil shocks of 1973 and 1974 led to wholesale price inflation of more than 30% by 1974 in 1975 the bank of Japan (the Japanese central bank)announced that it would target the growth rate of the Japanese M2 in order to reduce inflation. The consistency with which the Bank of Japan fulfilled its promises quickly bolstered its credibility. The central bank did indeed succeed in
reducing inflation in the 1980s and did so without large losses in output and employment. What do these episodes tell us?the experiences of the United States and Japan illustrate that a prolonged effort by the central bank to reduce the rate of growth of the nominal money supply will reduce inflation. The importance of credibility in determining the costs of disinflation is striking. on the one hand,the U.S.federal reserve system,with low initial credibility and a poor performance in hitting its announced money growth targets a recession and significant unemployment. on the other hand,the highly credible bank of Japan managed to reduce inflation with little direct output loss.

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