[MUSIC] Hi there. So, in this video we're going to have a look at central bank policies and concentrate on conventional policies. In a separate video, we will have a look at unconventional ones. The outcome with this video you will first find out about what central banks are targeting. Is it stronger economic growth, full employment, low inflation, currency stability, financial market stability? We will see that the value of central banks may have different or be it converging a mandate. We would also see that central banks may have conflicting goals and the problem is that if you have only one tool to master, to fulfill two conflicting goals then you have a problem. And finally, last but not least, we will see that monetary policy entails a fundamental asymmetry. It is far easier for a central bank to cool down an overheating economy, which translates into too strong a credit demand, than it is to try to stimulate the economy, as the world economy is actually, the current situation, where most of the economies experience weak economic growth. And central banks are conducting aggressively and central banks are aggressively easing monetary policy in an attempt to boost economic growth. And we will see that these expansionary monetary policies do not necessarily translate into higher economic growth. Okay, but now let's first look at what the main objectives are of the various central banks. Indeed, we always talk about a dual mandate for the US Central Bank, or the Federal Reserve. I actually see three, as you can see from this slide. Basically, they talk and, first off, insuring maximum employment, then stable prices. And there's also a third, which is objective, which is less known, is to have moderate long term interest rates. Here, the emphasis is on the first two. Maximum employment first and low inflation second. But there's a possible exception of another dual mandate, and that's the Swiss National Bank. Although it expresses this dual mandate, this dual objective in a way that it actually looks as just one objective. For indeed, the Swiss National Bank says that it wasnt to insure price stability and in so doing, take due account of economic development. So the Swiss National Bank says, if we target low inflation to keep inflation at bay. To keep inflation as low as possible. Then we create an economic environment which is such that companies make a lot of investment create a lot of jobs. And so low inflation insures high economic growth. That's in my view not something which is certainly happening all the times. I'm not sure that ensuring just low inflation brings high economic growth. But, when we look at the ECB for instance, the European Central Bank. They also stay in the same camp. Targeting inflation is the most important thing and this, ensuring price stability in the Eurozone, will make sure that economic growth is here to stay. The Bank of Japan and the Bank of England. They focus on maintaining monetary and financial stability. The Bank of Canada and Reserve Bank of Australia. They focus on the value of the currency. And the People's Bank of China is a combination of the Bank of Japan and the Bank of Canada for the aim of monetary policy in China is to maintain the stability of value of the currency and thereby promote economic growth. Now, if we want to really be precise, we may argue, we know, we've seen this in another video that or the raining B is actually under valued wether we measure it according to the big mac parody or by other measures including relative PPP. So clearly, maintaining a stable value of the at an undervalued level will insure economic growth. But let us assume that maybe in ten years time the Rem M B is over valued, keeping it stable at this over valued level, clearly will not ensure economic growth. But that's a separate subject and we can talk about it when we get there which is not for tomorrow. Okay. So now we've seen that the central banks have may have different mandates although at least in their minds they are converging for most of them do believe that when you ensure low inflation you make sure that the economic growth is there. And indeed, when we look at the traditional boom and bust cycle which we see here in this circle, starting way above, we see here that economic growth is stimulated by a previous fall in interest rates, which is actually the tool that central banks use in terms of conventional policy. Economic growth is stimulated thus. This stimulus of economic growth translates into higher demand for employment, and demand, and for raw materials. And eventually, this translates into skill shortages and supply problems, which translate into higher wages and inflationary pressure. So we get strong economic growth that produces higher inflation, inflation picks ups. It's the so-called cost push inflation. And then, the central nank steps in again. And raises interests rates. And this rising interest rates actually slows down demand and the economy and then we end in the bust, in the bust cycle. Economic growth slows, the central banks step in again, interest rates fall and we have stimulating again and this we have the Boom/Bust cycle. So conventional policies of central bank focus on this main instrument. It used to be money supply in the old days. But now, it's mostly interest rates. And, as we will see in a separate video, this is the conventional policy. But the problem is most central banks, once you reach zero, where the interest rate, then [LAUGH] that's it. It's the end of conventional policy and it's the beginning of unconventional was but that is a separate video. Now, when we look at these various objectives that central banks have, we have a problem which has been illustrated by this man. His name is Jan Tinbergen, and he was actually the first economist to win the Nobel Prize. This was in 1969, and he made a famous contribution, which we can illustrate with the allegory of central banks not being able to kill two birds with one stone. They need two stones for the two birds, meaning, if you have two objectives, you need Two tools. Just to illustrate, if for instance you have both inflation and unemployment which is typically now that situation that Brazil is experiencing then you can not have monetary policies tackling both. Targeting both. You cannot, you have to choose. Either you raise interest rates to chalk up to bring inflation down, or you're lowering interest rates to stimulate growth. But you see that there you're stuck and you have to. You have to decide, because there are two conflicting goals. So basically, what Mr. Tinbergen said, he said, we need as many tools as there are objectives. Another example, which is very actual. Is here in Switzerland. The Swiss National Bank has two conflicting goals. It has a very strong currency as we have seen when we talked about PPP, the Swiss Frank is the most overvalued currency in the world so it's way too strong and this is posing a serious problem and a threat of deflation in Switzerland. Because of this over valued currency. So the Swiss National Bank would like to lower interest rates in an attempt to lower the value of the Swiss Frank especially Visa Ve the Euro for the Euro's own Is the main trading partner of Switzerland. But, it cannot lower these interest rates because, on the other hand, there's too much credit in Switzerland, too much domestic credit, especially in the real estate. In the housing market. So, the Swiss National Bank views that there is some kind of housing bubble in Switzerland. And so, it cannot lower interest rates to lower the value of the Swiss Franc, because it would exacerbate credit demand and inflate this housing bubble further. So here, we have Mr. Tinbergen principle which is very well illustrated. We have two conflicting goals, and just with one tool you cannot address that. So the way to solve this problem is to have two tools, an additional tool which is called the macro potential measure. And here, in this instance, we address separately. We try to keep the Swiss Franc as low as possible with interest rates. But we address the problem of possibly excessive credit demand in the banking sector, especially for mortgages, by imposing higher capital requirements in the banking sector. [MUSIC]
