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The Financial System, Financial Regulation and Central Bank Policy

The Financial System, Financial Regulation and Central Bank Policy PDF

Author: Thomas F. Cargill

Publisher: Cambridge University Press


Publish Date: October 6, 2017

ISBN-10: 1107689767

Pages: 424

File Type: PDF

Language: English

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Book Preface

There are many excellent monetary economics textbooks in terms of coverage and  pedagogical tools written by accomplished monetary economists. So why another  textbook? This book differs from the traditional money and banking textbook in  three significant ways: first, it offers a unifying framework; second, it approaches  many topics from a different perspective from other textbooks; and, third, it offers  a less encyclopedic approach than that presented in other textbooks.

Unifying Framework in This Book

The topics and the order of chapters are presented in the context of a unifying  framework referred to as the nation’s financial and monetary regime. The nation’s  financial and monetary regime consists of these three parts: 1) the financial system;  2) government regulation and supervision; and 3) central banks and central bank  policy. Each component of the regime is addressed in a logical order so that the  student can obtain a unified perspective of the most important topics covered in a  monetary economics course.

Approach to Topics in This Book

In the context of the unifying framework of the nation’s financial and monetary regime, this book offers different perspectives, both in terms of pedagogical presentation and issues.

First, discussion of central bank policy itself is organized around a five-step sequence to assist student understanding of the role of central banks and central  bank policy: 1 ), the central bank; 2), the tools of monetary policy; 3 ), policy instruments; 4), the model; and, 5), the final policy targets. Like the unifying framework  of the nation’s financial and monetary regime, this five-step sequence provides a unifying framework for the student to organize the many elements of central banks and central bank policy.

Second, the book aims to incorporate history and policy along with the analytical  concepts necessary to understand the nation’s financial and monetary regime; that  is, the subject is viewed more from a political economy perspective than from the  analytical and detailed model perspective of most traditional textbooks. The analytical subjects are not central to the book and are developed only to the extent necessary to understand the nation’s financial and monetary regime. The IS/LM model is  not included. Instead, the “old” and “new” Phillips curves, along with a brief introduction to the AD/ AS model, are used to illustrate the relationship between central  bank policy and the economy. Rather than devote space to a detailed macroeconomic model, more attention is devoted to the three major periods of economic  distress in the United States – 1 ), the Great Depression; 2), the Great Inflation;  and, 3), the Great Recession- as well as two periods of a stable macroeconomic  environment: 4), the Great Moderation; and, 5), financial liberalization.

Third, the book emphasizes the interaction between government financial policy  and central bank policy as the source of much economic and financial distress and,  unlike traditional textbooks, focuses on the problems of Federal Reserve policy.  The majority of textbooks, in this writer’s opinion, devote insufficient attention to  the policy errors made by the Federal Reserve in the past. Some may regard this as  normative, but the large body of research now available suggests that the Federal  Reserve has importantly contributed to economic and financial distress far more  often than is discussed in the majority of commonly used textbooks. This book  attempts to present a more balanced perspective of government policy failure versus market failure. There is indeed much market failure, and there is indeed much  necessity for government involvement in the financial and monetary regime to support economic growth, but, at the same time, there have been mistakes in monetary  policy and financial regulation that have generated economic and financial distress,  and this needs to be presented.

Fourth, this book presents a more realistic perspective of central bank independence. The treatment of central bank independence in traditional textbooks is often  superficial and misleading; for example, ignoring the distinction between de jure  and de facto independence; ignoring the documented close relationship between  the Federal Reserve and the government during the period of the Great Inflation  from 1965 to 1979; and failing to point out that formal independence has been  a rather poor predictor of good monetary policy outcomes, as manifested by the  experiences of the Federal Reserve and the Bank of Japan during the Great Inflation period. In contrast to most traditional textbooks, which downplay the political  economy of monetary policy and the public choice perspective of central bank policy, this book emphasizes the overwhelming evidence that the policy of the Federal  Reserve, despite its formal independence, has been strongly influenced by government. Central bank independence is more myth than reality

Fifth, the book emphasizes how the structure of the financial system and monetary policy interact and, at times, generate economic and financial distress. The  financial distress in the 1970s was not only due to inflation in the context of Regulation Q and other portfolio limitations but was also a well-documented failure  of the Federal Reserve to even take into account the resource allocation effects of  Regulation Q. The same error was made in the first few years of the new century,  when the Federal Reserve failed to take into account how an unprecedented easy  monetary policy combined with a financial structure designed to allocate credit to  imprudent mortgage lending supported by government-sponsored enterprises distorted resources and generated a bubble, such as had happened in Japan 15 years  earlier. The United States devotes significant resources to subsidizing the housing sector, with two suboptimal outcomes: first, in terms of homeownership, the United States ranks well below other countries that do not subsidize housing to the  same degree as in the United States; and, second, the subsidization of housing has  imposed a serious resource cost on the economy, especially in its contributing role  in the Great Inflation and the Great Recession.

Sixth, there is no serious debate in the economic profession over the long-run  neutrality of monetary policy, but considerable debate over the nonneutrality of  monetary policy in the short run. While current textbooks do a good job explaining the difference between the short- and long-run effects of monetary policy, the  detailed models presented in most traditional money and banking textbooks confuse students because the limits of monetary policy are not emphasized, implying  that monetary policy is capable of short-run stabilization, whereas institutional, historical and theoretical developments over the last four decades suggest that this is  not realistic. This book emphasizes the limits of central bank policy to a greater extent than the traditional money and banking textbooks.

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