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NIce post, Nick. I only read the first part of Sebastian Edwards' paper, and instantly had the same reaction: "of course a central bank trying to stabilize its own nominal economy will have to respond to external shocks, including those due to the monetary actions of other central banks." Only you put it so much more nicely then I ever could have.

Kenneth Duda
Menlo Park, CA

Thanks Ken! Just by chance, I happen to be on the committee of a very good Poli Sci(!) student whose PhD thesis is on whether the Bank of Canada is independent from the hegemonic US Fed, and had been talking about this distinction with her. So when I saw Sebastian's post, I already had my argument all lined up and ready to go.

I'm not sure I understand the distinction you're trying to make. Yes, the BoC can target what it wants, but if it can't implement it, isn't that the same thing as saying the target is not independant?

Ie, the BoC wants to 2% inflation. However, say the US/Canada are high correlated, and the Fed wants 1%. It seems possible that the actions required for BoC to get to 2% might be so astronomical that it's beyond what they have the resources for.

To use a recent example, the Swedish banking system wanted to target a certain level of inflation of the franc. But it simply got swamped out by QE, and they were forced to give up.

I don't see the difference in distinguishing between the BoC being able to target 2% but can't actually implement, instead of just saying it can't target 2%.

Also, i'd have to reread Sebastian's post, but it seems like he's saying that if the Fed increases interest rates, rather than dealing with it as a shock, emerging markets will partially adjust their interest rates higher, rather than dealing with it fully as a shock. Sure, the emerging markets could try to stay at say, 2%- but if the Fed goes from 2-2.5%, they may simply have to accept part of that, and increase their rates to say, 2.25%. They could stay on the 2% road, but Sebastian seems to be saying that for the most part, the banks are instead saying "this road is too difficult, we'll take something in between". Which in practice means that they aren't independent. There's probably some subtleties in certain situations, where making the road more difficult is not the same as forcing a change in targets, but in many cases they seem functionally identical.

josh; I though I was being perfectly clear!

The Bank of Canada CAN implement a 2% inflation target. We know this, because it has been doing it (plus or minus random shocks, because it doesn't have a crystal ball).

There are some targets it cannot implement, like a full employment target, or too low an inflation target. that would be true even if Canada were a totally closed economy.

And it was Switzerland, not Sweden, that tried to target a low inflation rate. Now the idiots are trying to target an inflation rate even lower. Read my post a couple of days back, about central banks that want to shrink.

Nick, The title of Edwards' article says it's an illusion, but not the article itself. The article says there is not completely policy independence under a managed float. And that claim seems correct.

I completely agree with your post, but I'm not sure it contradicts anything Edwards said, except the title of his article.

Scott: people talk about "managed float", but I have no idea what it means. "flexible exchange rates" is also almost meaningless. It means "not fixed", but that leaves 1,001 different possible monetary policy targets.

In the textbooks (e.g. Mundell-Fleming ISLMBP), "flexible exchange rates" really means "fixed money supply", but that is only one of those 1,001 different possibilities. It could also mean "target inflation", or "target NGDP", or "target the price of oil", etc.

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