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Comovements in monetary policy

Revealing international correlations with FRED

Reporters and Fed watchers in the U.S. usually think about monetary policy in a domestic framework. But because business conditions, including commodity prices, are correlated internationally, central banks tend to move their policy rates up and down together and their inflation and interest rates tend to be correlated. FRED makes it easy to see these international comovements of macro and policy variables.

The first graph shows comovement in inflation rates from 1970 to the present for four economies: the U.S., Japan, the U.K., and the euro area. Inflation rose in the 1970s as central banks failed to combat the effects of commodity price increases on the general price level and inflation expectations became established.

Before the Financial Crisis of 2007-2009, almost all central banks in the developed world implemented monetary policy mainly by buying and selling short-term bonds to influence short-term interest rates or “policy rates.” The second graph shows the comovement in these policy rates from 1970 to the present for the Federal Reserve, the Bank of Japan, and the Bank of England: These central banks first hiked their policy rates in the 1979-1981 period to combat inflation and were then able to reduce those rates in the 1980s after inflation fell.

The second graph also shows that the Federal Reserve, the Bank of England, and the Bank of Japan lowered their short-term interest rates to zero during the Financial Crisis. To maintain price stability and continue to stimulate their economies, they turned to “unconventional” monetary policies that included buying long-term bonds to reduce long-term interest rates.

The value of the assets of central banks is one (albeit imperfect) way of measuring the monetary stimulus of unconventional policy. The third graph shows the assets of four central banks using an index for their values in 2008. The index value, rather than the value in each respective currency, allows a rough but easy comparison of the relative monetary stimulus. Central bank asset holdings have all increased greatly over the past decades. The Federal Reserve and the Bank of England had the first large responses in 2008-2009. The Bank of Japan began to accumulate assets in earnest starting in 2013. And the European Central Bank did likewise starting in 2015.

How these graphs were created: First graph: Search for “consumer price index for all urban consumers,” select the seasonally adjusted monthly version of the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the three series “Consumer Price Index of All Items in Japan,” “Consumer Price Index of All Items in the United Kingdom,” and “Harmonized Index of Consumer Prices: All Items for Euro Area (19 Countries).” For each of these four lines, change the units to “Percent Change from Year Ago.” Lastly, change the start date to 1970-01-01.
Second graph: Search for “effective federal funds rate,” select the appropriate monthly series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the monthly versions of the two series “Immediate Rates: Less than 24 hours: Central Bank Rates for Japan” and “Bank of England Policy Rate in the United Kingdom.” Lastly, change the start date to 1970-01-01.
Third graph: Search for “All Federal Reserve Banks: Total Assets,” select the appropriate series, and click “Add to Graph.” From the “Edit Graph” panel’s “Add Line” tab, add the three series “Bank of Japan: Total Assets for Japan,” “Total Central Bank Assets for United Kingdom,” and “Central Bank Assets for Euro Area (11-19 Countries).” For each of these four lines, change the units to “Index (Scale value to 100 for chosen date)” and select the date 2008-01-01. Lastly, change the start date to 2004-01-01.

Suggested by Chris Neely.


The ECB’s balance sheet continues to contract

At the press conference following the European Central Bank’s (ECB) meeting of the Governing Council on April 3, 2014, ECB President Mario Draghi commented on the state of the European economy and the scope of possible policy responses: He said that, in light of an “overall subdued outlook for inflation” and the “broad-based weakness of the economy,” the Governing Council “is unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation.” In today’s meeting, the ECB reaffirmed the possibility of using unconventional instruments, if necessary, to achieve its mandate.

Understandably, European financial markets have been speculating that the ECB will soon begin purchasing assets. This policy action, commonly known as quantitative easing (QE), would increase the size of the ECB’s balance sheet, though not necessarily in the same manner as QE has increased the size of the Fed’s balance sheet. As Draghi noted, the purpose of implementing a QE-style monetary program would be to accelerate the pace of real GDP growth, which remains sluggish, and raise inflation, which remains about 1.5 percentage points below its 2% target rate. The chart, which shows the asset side of the ECB’s balance sheet, illustrates why some European economic analysts expect the ECB to soon put in place a QE program. Unlike the Fed’s balance sheet, which continues to increase, the ECB’s balance sheet—as measured by the asset side—has been contracting for almost two years. Since July 2012, the ECB’s balance sheet has declined from a little less than 3.2 trillion euros to about 2.2 trillion euros. Many economists have found this decline a little puzzling, given that the ECB’s balance sheet was contracting as Europe fell into a recession (see this presentation by St. Louis Fed President Bullard). Whether this policy will succeed as intended is another matter: U.S. economists continue to debate the effectiveness of the Fed’s QE programs.

How this graph was created: In FRED, enter “ECB Assets” in the search box. The data are in levels (no transformation).

Suggested by Kevin Kliesen

View on FRED, series used in this post: ECBASSETS

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