Warren Mosler and Phil Armstrong
Published online 24th February 2019
Abstract
With floating exchange rate policies, central banks target policy interest rates – prices – rather than any monetary aggregate. The narrative favoured by central banks and academics is that of the central bank adjusting the quantity of reserves supplied in order to keep market rates in line with their target rate. This implies that, in the US case, for example, the Fed varies the quantity of reserves in order to achieve its interest rate target. However, we argue in favour of a reversed causality vis-à-vis orthodox analysis and contend that rather than adjusting the supply of reserves to meet its policy rate, as the monopoly issuer of reserves in a floating exchange rate regime, the central bank, in practice, acts as the price-setter for the level of reserves demanded by the banking system.
Key terms: Central Banking, Interest Rate Determination