Monetary Policy Formation at the Long-Term Margin: A Kahn-Tobin Framework

Abstract

During the last years, there is an increasing interest among central bank policy makers in the ‘portfolio rebalancing effect’, which stems from the imperfect substitutability of financial assets, and which can be generated by central bank open market operations (Andrés et al. 2004). The discussion over the ‘portfolio rebalancing effect’ echoes the earlier-generation debate between the ‘bills-only’ and the ‘bills-bonds’ approach. The ‘bills-only’ approach represents the ‘conventional’ position as it was shaped in the old debate that took place in the 1950s. According to the proponents of the ‘bills-only’ framework, the objectives of central bank policy should be achieved by open market operations in bills, but not in bonds. Thus, following this argument, the emphasis is on short-term treasury instruments rather than on longterm ones. Since the period in which this debate took place, the Federal Reserve Board applied almost always the ‘bills-only’ approach. The only exception was the application of the policy of ‘operation-twist’ in 1961.

I would like to thank Claudio Sardoni, Sheila Dow, Giuseppe Fontana and other participants at the Berlin Conference held in October 2005 on Macroeconomics and Macroeconomic Policies — Alternatives to the Orthodoxy for their comments on a preliminary version of this paper.