September 2016: Dr Juan Castañeda’s Bundesbank visit
Dr Juan Castañeda, Director of the IIMR, recently visited (July 2016) the Deutsche Bundesbank University in Hachenburg. There he gave a presentation to students on how to improve awareness about the relationship between the money supply and national income and government spending in the public eye. “For years, the monetary analysis in favour of inflation has been neglected. However, it is a crucial pillar for good central bank policy”. Referring to a number of historical evidence, Dr Castaneda show how a very volatile (and too high) money supply growth in 1945-1970 caused large swings in inflation growth and economic growth in Spain.
Dr Castañeda remarked “how important is independence for a central bank”, and for the bank to adhere to a credible policy rule “so all market participants can anticipate central bank decisions and plan for the future.” He then continued to explain the mathematical foundations of the ‘Taylor rule’, as it has been the benchmark used in academia and central banks to analyse and even prescribe policy decisions. Despite its general use, particularly prior to 2007/08, he highlighted the operational and theoretical flaws of this rule.
Referring to the euro zone, Dr Castañeda showed that interest rates in the running up to the Global Financial Crisis in 2008/09 were considerably lower than the Taylor rule’s prescriptions. This is confirmed when a money-based rule is used instead to guide policy decisions. He showed how a price stability monetary rule (such as the so called ‘Friedman rule’) would have advised a significantly lower rate of growth in broad money (M3); instead M3 growth in the euro zone grew very rapidly in those years and resulted in a non-sustainable increase in asset prices, output volatility and ultimately in monetary and financial instability.
Dr Castañeda concluded that stable monetary growth under the observation of monetary aggregates is the foundation for a successful monetary policy over the long term.
The visit continued with a discussion on theoretical foundations and current issues with members of the faculty and students of the university.