VI. Concluding Remarks

Carlo Cottarelli, and Curzio Giannini
Published Date:
December 1997
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This paper has presented a study of the adaptation of monetary frameworks in the quarter of a century following the demise of Bretton Woods. The absence in this period of recognized worldwide ground rules for the implementation of monetary policy explains the multiplicity of frameworks that have emerged in developing and industrial countries. The paper has, however, shown that, despite differences in specific country experiences and the lack of a grand plan for monetary reform, monetary frameworks did evolve along some clearly discernible patterns, as a response to developments in the macro-economic environment, economic theory, and popular preferences.

More specifically, the following main conclusions can be drawn from the analysis.

First, the most apparent trend has been the shift toward discretion in the use of monetary policy instruments. This trend was dominated by the gradual abandonment of exchange rate targets both in developing countries (where the process has proceeded gradually and smoothly) and in industrial countries (where the shift has been less smooth). Thus, the “tying one’s hands” representation of monetary policy—the adoption of rules to achieve credibility—seems to have become less and less apt to describe actual trends. It has also been shown that the switch toward greater discretion is identifiable not only on average, but also when focusing on countries involved in anti-inflationary efforts.

Second, at the same time, there has been an attempt to conjugate greater flexibility of response with long-run anti-inflationary credibility (or credibility of purpose). This attempt has hinged on three by-now widely shared beliefs, namely that (1) credibility of purpose is indeed the crucial problem to be confronted in the reform process; (2) any policy that aimed at being believed should be based on clear and relatively simple announcements against which to evaluate subsequent policy actions; and (3) some form of delegation is likely to strengthen the credibility of the announced policy path.

Third, the new Weltanschauung, however, has emerged only gradually, and has taken different forms (or strategies). In particular, the paper has highlighted the increasing diffusion of four strategies to achieve credibility: (1) delegation of monetary policy to an independent central bank; (2) increased transparency of the monetary policy process and inflation targeting; (3) greater reliance on an outside source of credibility (for those countries accepting IMF conditionality); and (4) a heavy front-loaded investment in anti-inflationary reputation on the part of monetary authorities. It has also shown that the choice of strategy appears to have been influenced by the institutional environment of the country concerned and by the structure of the economy. In particular, developing countries have mainly chosen the third (and to some extent the first) path. In the industrial world, central bank independence and inflation targeting are instead becoming the dominant mode. At the same time, pure discretion buttressed by reputational forces has successfully been applied only in a very limited (and not increasing) number of countries. Nevertheless, it has been argued that reputation has played an important role in some countries, particularly when coupled with other credibility-enhancing devices. Finally, the paper has argued that the success of the above strategies in the long run ultimately rests on the maintenance of anti-inflationary preferences, which is an ethos of price stability, in the population at large. But, this by no means implies that institutions are irrelevant as institutions and preferences are mutually dependent.

Fourth, as to rule-based frameworks, the paper has shown that domestic anchors (monetary aggregates) have been much less popular than exchange rate anchors, particularly in developing countries. Moreover, they have usually taken milder forms than those adopted when the exchange rate was used as anchor, thus suggesting that monetary targeting often represented a way of giving a rule flavor to policies that remained centered on the flexibility of monetary instruments.

Fifth, in contrast, exchange rate targets were more common and typically took much stronger forms, thus setting correspondingly more binding constraints on monetary policy. At the same time, the paper has argued that the dominance of exchange rate anchors has to be explained also by factors lying outside the monetary domain: exchange rate targets have dominated because they represent targets per se, for either political or psychological reasons. Indeed, the paper suggested that the relative frequency of exchange rate rather than monetary rules confirms that strict adherence to rules, except under extraordinary circumstances, is not an appealing option for monetary authorities unless rules are needed for reasons unrelated to monetary control.

Sixth, the paper argued that one of the factors behind the gradual shift away from exchange rate pegs was the trend increase in capital mobility over the last quarter of a century. If the present trend toward greater capital mobility continues (as we believe will likely be the case, as the process reflects irreversible technological and financial developments), exchange rate pegs are unlikely to come back on stage, except in countries willing to go beyond mere pegging arrangements, toward more extreme forms of monetary policy delegation (such as currency board or monetary unions, as in the case of EMU countries).

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