Some Theoretical Aspects of Base Control

Abstract

This paper focuses on the implications of using the monetary base or bank reserves as an instrument to control a monetary aggregate. Following analysis of a series of theoretical models of increasing complexity, it is concluded that in a system with either institutional or structural lags base control may entail very sharp and possibly undamped oscillations of short-term interest rates. The shorter the time period over which the authorities choose to bring the monetary aggregate back to its target, the more volatile will be the movements of interest rates. Furthermore, there is an asymmetry in the U.S. institutional structure such that rigid implementation of the base control system will under certain circumstances lead to a decline in short-term interest rates to very low levels. The final section of the paper is devoted to the examination of the Canadian institutional structure emphasizing the differences between the U.S. and Canadian systems.

Monetary Aggregates as Targets: Some Theoretical Aspects

“…The important operational question of whether the central bank uses base control or interest rate control as its mechanism for affecting the growth of the monetary agqreqate will not be addressed in this paper. See Freedman (1981) for an analysis of some of the implications of using the monetary base or bank reserves to control a monetary aggregate.…”