What the Europe’s plan to end crisis

1 11 2011

YOU can understand the self-congratulation. In the early hours of October 27th, after marathon talks, the leaders of the euro zone agreed on a “comprehensive package” to dispel the crisis that has been plaguing the euro zone for almost two years. They boosted a fund designed to shore up the euro zone’s troubled sovereign borrowers, drafted a plan to restore Europe’s banks, radically cut Greece’s burden of debt, and set out some ways to put the governance of the euro on a proper footing. After a summer overshadowed by the threat of financial collapse, they had shown the markets who was boss.

Yet in the light of day, the holes in the rescue plan are plain to see. The scheme is confused and unconvincing. Confused, because its financial engineering is too clever by half and vulnerable to unintended consequences. Unconvincing, because too many details are missing and the scheme at its core is not up to the job of safeguarding the euro.

This is the euro zone’s third comprehensive package this year. It is unlikely to be its last.

Words are cheap…

The summit’s most notable achievement was to forge an agreement to write down the Greek debt held by the private sector by 50%. This newspaper has long argued for such a move. Yet an essential counterpart to the Greek writedown is a credible firewall around heavily indebted yet solvent borrowers such as Italy. That is the only way of restoring confidence and protecting European banks’ balance-sheets, thus ensuring that they can get on with the business of lending.

Unfortunately the euro zone’s firewall is the weakest part of the deal (see article). Europe’s main rescue fund, the European Financial Stability Facility (EFSF), does not have enough money to withstand a run on Italy and Spain. Germany and the European Central Bank (ECB) have ruled out the only source of unlimited support: the central bank itself. The euro zone’s northern creditor governments have refused to put more of their own money into the pot.

Instead they have come up with two schemes to stretch the EFSF. One is to use it to insure the first losses if any new bonds are written down. In theory, this means that the rescue fund’s power could be magnified several times. But in practice, such “credit enhancement” may not yield much. Bond markets may be suspicious of guarantees made by countries that would themselves be vulnerable if their over-indebted neighbours suffered turmoil.

Under the second scheme, the EFSF would create a set of special-purpose vehicles financed by other investors, including sovereign-wealth funds. Again, there are reasons to doubt whether this will work. Each vehicle seems to be dedicated to a single country, so risk is not spread. And why should China or Brazil invest a lot in them when Germany is holding back from putting in more money?

Together, these schemes are supposed to extend the value of the EFSF to €1 trillion ($1.4 trillion) or more. Sadly, that looks more like an aspiration than a prediction. And because the EFSF bears the first losses, its capital is at greater risk of being wiped out than under a loan programme. This could taint France, which finances the rescue fund and has recently seen its AAA credit rating come under threat. Since the EFSF depends partly on France for its own credit rating, a French downgrade could undermine the rescue fund just when it is most needed.

If the foundations of the firewall are too shallow, then the bank plan plunges too deep. By the end of June 2012, banks are expected to establish a core-capital ratio of 9%. In principle, that is laudable. But if banks have months to reach their target, they can avoid raising new equity, which would dilute their shareholders’ stakes, and instead move to the required ratio by shrinking their balance-sheets. That would be a terrible outcome: by depriving Europe’s economy of credit, it would worsen the downturn.

Then there is Greece. Although the size of the writedown is welcome, euro-zone leaders are desperate for it to be “voluntary”. That is because a default would trigger the bond-insurance contracts called credit-default swaps (CDSs). The fear is that a default could lead to chaos, because the CDS market is untested. That is true, but this implausibly large “voluntary” writedown will lead investors in other European sovereign bonds to doubt whether CDSs offer much protection. So while the EFSF scheme is designed to offer insurance to bondholders, the European leaders’ insistence that the Greek writedown be voluntary will make euro-zone debt harder to insure.

…but trust is nowhere to be found

Europe has got to this point because German politicians are convinced that without market pressure the euro zone’s troubled economies will slacken their efforts at reform (see article). Despite a list of promises presented to the summit by Silvio Berlusconi, Italy’s prime minister (see article), Germany has good reason to worry. But it needs to concentrate on institutional ways of disciplining profligate governments, rather than starving the rescue package of funds. As it is, this deal at best fails to solve the euro crisis; at worst it may even make it worse. As the shortcomings of each component become clear, investors’ fears will surely return, bond yields will rise and banks’ funding problems will worsen.

Yet again, disaster will loom. And yet again, the ECB will end up staving it off. Fortunately, Mario Draghi, the ECB’s incoming president, made it clear this week that he realises that is his job. But therein lies the tragedy of this summit. An ECB pledge of unlimited backing for solvent governments would have had a far better chance of solving the crisis months ago, and remains the best option today.

At this summit Europe’s leaders had hoped to prove that their resolve to back the euro was greater than the markets’ capacity to bet against it. For all the backslapping and brave words, they have once again failed. There will be more crises, and further summits. By the time they settle on a solution that works, the costs will have risen still further.

Source: The Economist


Flights In Qantas Is Restore

31 10 2011

SYDNEY—Qantas Airways Ltd. began to restore service Monday after an Australian tribunal ruled to end a prolonged labor dispute that had forced the airline to ground its fleet world-wide over the weekend.

Stranded travelers sit inside the Qantas Airways Ltd. domestic terminal at Sydney Airport in Australia on Sunday.

Dispute Disrupts Flights

Passengers wait at the Qantas counter at Hong Kong International Airport after their flight to Sydney was canceled Saturday.

The flagship Australian airline had shut down its domestic and international flights in a surprise response to an escalating workers strike over pay and conditions, leaving about 70,000 travelers stranded.

Earlier, a representative for Qantas had said the airline hoped to restore service as soon as Monday subject to regulatory approval, but that it could take days to clear the backlog of flights. The airline—the world’s 10th largest by traffic—accounts for about 40% of domestic flights.

The decision by Qantas management to ground its entire mainline fleet marked the high point of a wave of strikes that has struck the global airline industry this year.

Airlines in Europe, North America and parts of Asia have been hit by strikes recently, driven by employee discontent over a lack of payback for concessions granted in previous years and perceived mismanagement by executives. The Qantas ruling came as flight attendants at Air France-KLM’s Air France unit prepared to start a five-day stoppage over pay and work rules.

The Australian airline and its stranded passengers pin their hopes on the decision of a government appointed labour tribunal. Video courtesy Reuters.

Workplace-relations body Fair Work Australia was called on by the government to end the labor strike at Qantas to avoid “significant damage” to the Australian economy, especially tourism.

“We’re conscious the Australian economy has been put at great risk of damage” due to the strike, Assistant Treasurer Bill Shorten, a former union official and now a key person in the prime minister Julia Gillard’s Labor government, said after the ruling.

Qantas said that so far the months-long labor dispute has cost it 68 million Australian dollars (US$73 million).

Unions representing engineers, baggage handlers and pilots have engaged in protracted strikes over the Australian flag carrier’s plan to establish new Asia-based airlines to better tap rising regional demand and lower its costs. Some of the unions are also making pay claims that Qantas says are excessive.

Qantas CEO Alan Joyce was criticized for grounding the fleet without notice a day after the company’s annual general meeting approved an increase in his salary to about A$5 million.

Government ministers and unions stepped up their rhetoric against Qantas on Sunday. Mr. Shorten said the decision to ground the flights was a “high-handed ambush.”

Australian airline Qantas says it is grounding its entire fleet around the world due to a protracted labor dispute. Video courtesy Reuters.

Business groups had warned Sunday of the potential damaging effects the flight disruptions could cause companies that rely on fly-in workers in industries such as mining. “This is an operational hassle that is just not necessary in 2011 and is a bad look not only for the resources sector but Australia as a whole,” Reg Howard-Smith, CEO of the Chamber of Minerals and Energy of Western Australia, said in a written statement Sunday.

Australian mining giant BHP Billiton Ltd.—the country’s largest listed company—played down the impact of the dispute on its operations.

“As the majority of regular flight services to our Australian operations are operated by airlines other than Qantas, we do not expect a significant impact to the business,” spokeswoman Kelly Quirke said. “For those employees and operations that have been directly impacted, we are developing contingency plans, including the use of charter services where possible.”

Some 108 aircraft were grounded in 22 airports around the world. Refunds have been offered, and Qantas has promised to pay for food and accommodation to those in transit.

Jetstar, the low-cost international arm of Qantas, wasn’t included in the shutdown, nor were some smaller regional operations.

Travelers walk through an empty Qantas terminal in Sydney on Sunday. Airline service was restored Monday.

Other international airlines were preparing to add capacity with extra flights or larger planes on services to Australia, including Malaysia’s AirAsia X, an affiliate of AirAsia Bhd., and Qantas’s partners in the Oneworld alliance, British Airways PLC and Cathay Pacific Airways Ltd. into Monday.

The dispute is an embarrassment for Prime Minister Julia Gillard, coming as she hosts the Commonwealth conference with hundreds of diplomatic and government officials from around the 54 member states gathered here for talks, in a city where air transit is dominated by Qantas. Some 17 heads of state flew to the meeting on board the flagship airline and are now receiving assistance from Australian officials in sourcing alternative outward flights.

Unions accused Qantas management of having planned the lockout weeks in advance and said it was a reckless course.

“It is an insane reaction,” said Richard Woodward of the Australian and International Pilots Association. “We think they are risking the great Australian icon.”

Source: Wall Street Journal

HP Pavilion dv6-6110us

31 10 2011

HP Pavilion dv6-6110us.

Sell Islamic Bond to anticipate Crisis

24 10 2011

The following borrowers are expected to sell Islamic bonds, which use asset returns to pay investors to comply with the religion’s ban on interest. Global sales of sukuk climbed to $18.1 billion in 2011, from $12.7 billion a year earlier, according to data compiled by Bloomberg.

KUVEYT TURK KATILIM BANKASI AS: A Turkish Islamic bank part-owned by Kuwait Finance House (KFIN) KSC got approval to sell $350 million of Islamic bonds, the market regulator in Ankara said in a weekly report published on its website.

ALMARAI CO.: Saudi Arabia’s largest food producer by market value may set up its first Shariah-compliant bond program by early 2012, Chief Financial Officer Paul-Louis Gay said in an e- mailed response to questions. The riyal sukuk would be available only to the local market and would help finance an “ambitious capital expenditure development plan and working capital needs,” he said.

INDONESIA: The government may sell $500 million of sukuk this year in its second such global offering, Dwi Irianti Hadiningdyah, deputy director of Islamic finance at the debt management office, told reporters. “We may upsize the offering depending on demand,” she said. Government officials are meeting investors in Riyadh, Doha, Abu Dhabi and Dubai from Oct. 16 to Oct. 18, according to a person familiar.

TENAGA NASIONAL BHD. (TNB): Malaysia’s biggest power producer was assigned a preliminary AAA credit rating for its proposed 5 billion ringgit ($1.6 billion) Islamic bond sale by RAM Rating Services Bhd. The 28-year sukuk program will be offered by Tenaga unit Manjung Energy Island Bhd. to partially fund a new coal-fired power plant, RAM said in a statement. The company will sell the sukuk in October and the marketing will begin in the third week, Bernama reported Sept. 15, citing Chief Executive Officer Che Khalib Mohamad Noh.

MYDIN MOHAMED HOLDINGS BHD.: A Malaysian operator of hypermarkets and convenience stores, plans to sell 350 million ringgit of Islamic bonds, RAM Rating Services Bhd. said. The notes will be backed by state bond-guarantee agency Danajamin and have been rated AAA, RAM said.

BARWA BANK: The unit of Qatar’s biggest property developer by assets Barwa Real Estate Co. (BRES), plans to sell Islamic bonds in 2013 after it gets a credit rating, Chief Executive Officer Steve Troop said.

MAJID AL FUTTAIM HOLDING LLC: The Dubai-based operator of Carrefour SA stores in the Middle East is considering setting up a Shariah-compliant bond program, group treasurer Daniele Vecchi said. The company hasn’t decided on the size or the timing of the sale, he said.

SAUDI ARAMCO TOTAL REFINING & PETROCHEMICAL CO: The company, also known as Satorp, may sell a second Islamic bond after the sale of the company’s first sukuk was oversubscribed, Jamal Al-Rammah, chief of corporate finance for Saudi Arabian Oil Co., the Saudi partner, said at a news conference in Dammam. Satcorp is a joint venture between Saudi Arabian Oil Co. and France’s Total SA.

ISLAMIC BANK OF THAILAND: The state-owned lender plans to raise 5 billion baht ($163 million) in the country’s first domestic sale of sukuk this year, Dheerasak Suwannayos, president of the Bangkok-based bank, said in an interview. The bank is awaiting clarification from government regulators on tax breaks for Shariah-compliant bonds before proceeding with the baht-denominated sukuk. It will sell $150 million of Islamic bonds overseas once the local-currency Islamic bond is completed, Dheerasak said.

ABU DHABI NATIONAL ENERGY CO. (TAQA): The state-owned utility, also known as Taqa, plans to sell as much as 3.5 billion ringgit of Islamic bonds in Malaysia, according to a statement to the Abu Dhabi bourse.

TAMWEEL PJSC (TAMWEEL): The mortgage company majority-owned by Dubai Islamic Bank PJSC, plans to raise $300 million to $500 million from the sale of Islamic bonds in the fourth quarter, its first debt sale since 2008, acting Chief Executive Officer Varun Sood said in Dubai. The offering will be denominated in dollars or ringgit, he said.

QATAR INTERNATIONAL ISLAMIC BANK (QIIK): The Persian Gulf country’s biggest Shariah-compliant lender plans to sell a five- year, benchmark-size dollar sukuk “when market conditions permit,” Chief Financial Officer Edward Wong said in a telephone interview from Doha.

BAHRAIN: The country plans to sell $1 billion of Shariah- compliant debt in October to finance the budget deficit, central bank Governor Rasheed al-Maraj said in an interview.

ALBARAKA BANKING GROUP BSC: Bahrain’s biggest publicly traded Islamic lender and its unit in Turkey may raise a total of $500 million from sukuk this year, Chief Executive Officer Adnan Ahmed Yousif said in an interview in Washington. Albaraka Turk Katilim Bankasi AS (ALBRK) is in the process of hiring banks to manage a sale of about $200 million by November, while the parent bank may sell about $300 million by the end of the year, Yousif said.

PALESTINE MONETARY AUTHORITY: The central bank plans to issue $50 million of Islamic debt this year, Jihad Al Wazir, governor of the Palestine Monetary Authority, said in an interview.

AL HILAL BANK: The state-owned lender in the United Arab Emirates plans to raise $500 million from the sale of Islamic bonds in the fourth quarter, Mohamed Berro, the chief executive officer, said in an interview. The offering is part of a $2.5 billion sukuk program set up by the Abu Dhabi government- controlled Islamic bank, he said.

EMERY OLEOCHEMICALS GROUP: The producer of plastic additives is proceeding with plans to sell 480 million ringgit of Islamic bonds in the fourth quarter, CEO Kongkrapan Intarajang said. Emery is a joint venture between PTT Chemical International Private Ltd., a unit of PTT Chemical Pcl, and Sime Darby Plantation Sdn., owned by Malaysia’s Sime Darby Bhd.

PT BANK MUAMALAT INDONESIA: Indonesia’s second-largest Islamic bank will sell $50 million of dollar-denominated sukuk with a maturity of not more than five years in 2011, Hendiarto, chief financial officer at the bank, told reporters on July 21. The lender is also planning to sell 800 billion rupiah ($90 million) of local-currency Islamic bonds in 2012, Hendiarto said.

INTERNATIONAL ISLAMIC LIQUIDITY MANAGEMENT CORP.: The global institution set up by central banks from countries including Malaysia and Bahrain plans to sell $200 million to $300 million of short-term Islamic bills before the end of 2011, Chief Executive Officer Mahmoud AbuShamma said in an interview. The first issuance will likely have a maturity of three months and will be denominated in dollars, he said. IILM will also sell Shariah-compliant bonds maturing in more than five years, AbuShamma said, declining to give a timeframe.

ACWA POWER INTERNATIONAL: The Saudi Arabia-based developer of electricity and water projects may sell $300 million of Islamic debt next year, CEO Paddy Padmanathan said in Dubai. The company is seeking funds for utility investments.

AL BARAKA BANK EGYPT ESC: The Cairo-based Islamic unit of Albaraka Banking Group (BARKA) BSC expects to raise 1 billion Egyptian pounds ($168 million) from the sale of 10-year Islamic bonds, Manama-based CEO Adnan Ahmed Yousif said in an interview.

JORDAN: Jordan’s government plans to sell as much as $750 million of Shariah-compliant debt to finance its budget deficit and fund infrastructure projects, said Finance Minister Mohammad Abu Hammour.

NIGERIA: Nigeria wants to sell its first Shariah-compliant bonds within 18 months as sub-Saharan Africa’s second-largest economy aims to become a “hub of Islamic finance” in the region, central bank Governor Lamido Sanusi said.

SENEGAL: The West African nation’s $200 million sukuk to be sold later this year will be used for budgetary support, said Finance Minister Abdoulaye Diop. “We simply want to experiment, to diversify our sources of income,” Diop said.

RUSSIA: Executives from OAO Gazprombank, the lending arm of gas export monopoly OAO Gazprom, are seeking support for issuance of Islamic bonds by as many as five companies, Alexander Kazakov, director of structured and syndicated finance at the bank, said in an interview in Jakarta. Tatarstan, a Muslim-majority Russian republic, will announce a dollar- denominated sale soon, according to Kuala Lumpur-based adviser AmanahRaya Investment Bank Ltd.

PT BANK SYARIAH BRI: The Islamic banking arm of Indonesia’s second-largest lender by assets may sell sukuk in the next one to two years to support expansion, President Director Ventje Rahardjo told reporters in Jakarta.

KAZAKHSTAN: The government may sell at least $500 million of Islamic bonds once parliament approves a law on Islamic finance, Finance Minister Bolat Zhamishev said in an interview in the capital Astana.

POH KONG HOLDINGS BHD. (PKH): The Malaysian jewelry maker plans to sell 150 million ringgit of Islamic debt, which will be backed by Danajamin Nasional Bhd., a state bond guarantee agency, the company said in a Kuala Lumpur exchange filing.

SAUDI ELECTRICITY CO. (SECO): The state-owned utility may sell as much as $1.5 billion in Islamic bonds by the end of this year or early 2012, CEO Ali Al-Barrak told reporters at a conference in Dubai.

TOURISM DEVELOPMENT & INVESTMENT CO.: The Abu Dhabi government-backed developer of hotels and museums may sell bonds with maturities of seven to 10 years in 2011 to finance projects, Director of Finance Wallace Long said. The debt may be conventional or Islamic, he said.

ABU DHABI ISLAMIC BANK (ADIB) PJSC: The United Arab Emirates’ second-biggest Shariah-compliant lender may sell Islamic bonds by the end of this year to help repay an $800 million sukuk that matures in December, CEO Tirad Mahmoud said at a news conference.

MASRAF AL RAYAN (MARK): Qatar’s second-largest Islamic bank plans to sell as much as $1 billion of sukuk in the fourth quarter after its board received shareholder approval, Chairman Hussain Ali Al-Abdalla said.

UNITED ARAB EMIRATES: Abu Dhabi may sell $1.5 billion in bonds in 2011 to create a long-dated benchmark, while Dubai, its smaller neighbor, also may issue $1.5 billion to fund its budget, Standard Chartered Plc said in a March 7 report.

SOUTH AFRICA: The biggest African economy will amend legislation to allow the government to sell Islamic bonds to finance spending, Lungisa Fuzile, head of asset and liability management at the Treasury, said in an interview in Cape Town.

FRANCE: The country’s first Islamic bond may be sold in 2011 after the government introduces guidelines for sukuk offerings, said Thierry Dissaux, chief executive officer of the French Deposit Guarantee Fund. The debt may be in dollars and euros, he said.

Source: http://www.bloomberg.com

In Global Economic Slowdown, Sub-Saharan Africa is expected Growth 6% in 2012

22 10 2011

The International Monetary Fund (IMF) today released the October 2011 Regional Economic Outlook: Sub-Saharan Africa. Ms. Antoinette Monsio Sayeh, Director of the IMF’s African Department commented on the report’s main findings:

Recent Developments

Growth has remained strong in the region in recent years, and most low-income countries in Africa weathered the global economic slowdown well. The Regional Economic Outlook projects that growth in sub-Saharan African (SSA) economies will remain on average above 5 percent in 2011. The growth rate is expected to increase in 2012 to nearly 6 percent, because of one-off boosts to production in a number of countries. Beneath these good overall trends for SSA, however, there is considerable diversity.

  • Most low income countries (LICs) have been doing very well. One third of LICs are expected to grow by more than 6 percent in 2011. But poor households have been hit hard by rising food and fuel prices, and famine is devastating the Horn of Africa.
  • Some middle income countries were severely affected by the global crisis. In South Africa, with unemployment stubbornly high, growth will be limited to at most 3½ percent this year.
  • • Oil exporters have enjoyed the fruits of elevated oil prices, and the non-oil sectors in their economies are projected to grow by 7½ percent this year.

“But there are significant downside risks to this outlook.

  • Global financial volatility and a sharp slowdown in growth in advanced countries would affect SSA by subduing export demand and private financing flows, restricting growth particularly in the region’s more integrated economies.
  • Volatility in commodity markets could cause further disruptions in macroeconomic balances, with both winners and losers within the region.

“There are also risks from within the region.

  • Inflation rates have begun to rise again, driven in the first instance by rising food and fuel prices. Consumer prices rose on average by 10 percent in the year to June 2011, up from 7½ percent a year earlier. And some countries have seen much sharper increases in inflation, extending beyond the immediate impact of higher food and fuel prices.”

Ms. Sayeh concluded: “Policies need to tread a fine line between addressing the challenges posed by strong growth and preparing to ward off the potentially adverse effects of another global downturn. At the same time, Sub-Saharan Africa needs to continue to invest in growth and employment, which are critical for sustained poverty reduction.”

Inclusive Growth

Introducing the Regional Economic Outlook chapter ‘How Inclusive has Africa’s Recent High Growth Episode Been?’ Ms. Sayeh said: “New evidence from household surveys shows that the average living standards of relatively poor households in some fast-growing economies rose strongly in the early 2000s. Comparing across countries, the poorest 25 percent of households fared best in countries where economic growth was higher.

“This evidence sheds some light on an apparent enigma in aggregate data showing—at best—a very weak relationship between poverty and growth. It suggests that one important link in the chain between economic growth and poverty reduction is growth in agricultural employment. Cross-country differences in agricultural employment growth explain a large part of observed differences in the relative consumption growth of the poorest households among the countries sampled. The chapter also shows that real income growth may have been significantly underestimated in some countries, mainly because of biases in the way that consumer price inflation has been measured,” Ms. Sayeh noted.

Re-orientation of Trade

Commenting on Regional Economic Outlook chapter ‘Sub-Saharan Africa’s engagement with emerging partners’ Ms. Sayeh observed: “A fast-paced reorientation in SSA toward new markets is under way, with nontraditional partners now accounting for about 50 percent of the region’s exports and almost 60 percent of its imports. While the region’s exports are still heavily concentrated in oil, gas, and minerals, particularly in the case of its largest emerging partners—China, India, and Brazil—many emerging markets purchase a wider range of products. FDI into the region is also diversified, including infrastructure, agriculture, and telecommunications.

“This reorientation brings the usual benefits of greater international trade, but should also boost long-term growth by reducing volatility in exports and output. The emergence of new partners provides the region with both significant opportunities – lower cost of inputs and consumption goods, transfer of technology, and economies of scale – and challenges – managing high concentration of exports on commodities and rapid sectoral changes,” Ms. Sayeh said.


Non-Self-Averaging in Macroeconomic Models: A Criticism of Modern Micro-founded Macroeconomics

21 10 2011

Masanao Aoki
Department of Economics, University of California
Hiroshi Yoshikawa
Faculty of Economics, University of Tokyo

Download: Suggest, Quick


Using a simple stochastic growth model, this paper demonstrates that the coefficient of variation of aggregate output or GDP does not necessarily go to zero even if the number of sectors or economic agents goes to infinity. This phenomenon known as non-self-averaging implies that even if the number of economic agents is large, dispersion can remain significant, and, therefore, that we can not legitimately focus on the means of aggregate variables. It, in turn, means that the standard microeconomic foundations based on the representative agent has little value for they are expected to provide us with accurate dynamics of the means of aggregate variables. The paper also shows that non-self-averaging emerges in some representative urn models. It suggests that non-self-averaging is not pathological but quite generic. Thus, contrary to the main stream view, micro-founded macroeconomics such as a dynamic general equilibrium model does not provide solid micro foundations.


The contribution of the literature on endogenous growth ranging from Romer (1986) and Lucas (1988) to Grossman and Helpman (1991), and Aghion and Howitt (1992), has been to endogenize the underlying sources of sustained growth in per-capita income. The main analytical exercises in these papers are to explicitly consider the optimization by the representative agent in such activities as education, on-the-job training, basic scientific research, and process and product innovations. This approach is not confined to the study of economic growth, but actually originated in the theory of business cycles. Arguably, the rational expectations model by Lucas (1972, 73) opened the door to modern “micro-founded” macroeconomic theory. In the field of the theory of business cycles, it is now represented by the real business cycle theory (Kydland and Prescott (1982)):

“Real business cycle models view aggregate economic variables
as the outcomes of the decisions made by many individual
agents acting to maximize their utility subject to production possibilities
and resource constraints. As such, the models have an
explicit and firm foundation in microeconomics. (Plosser, 1989,


World map showing countries by nominal GDP per...

The Design of a ‘Two-Pillar’ Monetary Policy Strategy

20 10 2011

Meixing Dai
University of Strasbourg


In this paper, it is argued that money supply in a narrow sense and repo interest rate are two independent monetary policy instruments when the effect of interest rate policy cannot be efficiently transmitted to the economy through the monetary and financial markets. In this case, the control of money supply is necessary to reduce the discrepancy between the repo interest rate and the interest rates at which private agents lend and borrow. Using a simple macro-economic model, this study shows how a twopillar monetary policy strategy as practiced by the European central bank (ECB) can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. This strategy can be interpreted as a combination of inflation targeting and monetary targeting. Well conceived monetary targeting with a commitment to a long-run money growth rate corresponding to inflation target could reinforce the credibility of central bank announcements and the role of inflation target as strong and credible nominal anchor for private inflation expectations. However, an inflation-targeting regime associated with Friedman’s money supply rule can generate dynamic instability in output, inflation and money demand. Three feedback monetary targeting rules, of which the design depends on economic structure and central bank preferences, are discussed relative to their capability of warranting macroeconomic stability.

Over the last decade, more and more central banks have adopted a new framework for conducting monetary policy known as inflation targeting, which is presented by Mishkin (1999) as a successor to and more efficient in controlling inflation than monetary targeting. In this context, the two-pillar strategy of the ECB appears quite singular.

Several economists advocate that if money demand is stable at European level, monetary targeting makes a suitable concept for the ECB. Neumann and von Hagen (1995) suggest that monetary targeting is an effective device for anchoring medium-term inflation expectations. At the same time, this approach permits sufficient flexibility for leaning against the wind of currency appreciation and for responding to short-term events. In contrast, inflation targeting is likely to either prevent the ECB from gaining credibility or require responding to price level shocks in an overly contractionary fashion.

For von Hagen (1999), the Bundesbank’s experience suggests that a strategy of money growth targeting might help the ECB to successfully establish and assert its control over monetary conditions in the monetary union, to define its policy goals and its role in macroeconomic policy and to establish its reputation for consistently pursuing these goals over time.


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