Efficient and Universal Frameworks (EUF) for Monetary Policy Implementation

Compared with the period 1920-1990, the current monetary policy implementation techniques are relatively well-focused and transparent. In particular, (i) they mostly aim at achieving a well defined operational target (typically the overnight interest rate), (ii) monetary policy operations are not supposed to contain signals on the monetary policy stance, (iii) reserve requirements are kept stable, i.e. are no longer used as an active instrument of reserve absorption or injection. Still, particularly the large monetary areas’ central banks have preserved the luxury of a number of complexities. First, the fact that they use reserve requirements with averaging to absorb liquidity shocks creates a complicated and disturbing inter-temporal structure of liquidity demand. Second, operational frameworks of central banks are specified in such a way that officers responsible for monetary policy implementation occasionally or always need to apply significant discretion in conducting open market operations, and making unnecessary use of it creates non-transparency. Third, relating to the previous point, central banks tend to use auction procedures in their monetary policy operations in which the allotment decision contains discretionary elements. When bidding in such auctions, banks have to speculate about what the central bank has in mind in terms of eventually allotted quantity and rate. We argue in this paper that these three aspects of today’s monetary policy implementation may be anachronisms, and that the operational frameworks of central banks can be specified to overcome them. We introduce a set of monetary policy implementation frameworks we call “EUF”, i.e. frameworks which are efficient in the sense that they achieve their monetary policy objective in a socially efficient manner, and are universal in the sense that they do this across a wide range of financial and macro economic environments. We explain the toolbox that should in our view be used by such frameworks, and propose a simple modeling approach to understand the relationship between the framework specification, autonomous factor shocks, the control of the interbank overnight rate, and interbank market activity. We also review a number of central banks’ monetary policy implementation frameworks that we consider close to EUF