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Guides to Monetary Policy in a Global Economy
By Manuel H. Johnson
Introduction
Monetary policy is currently conducted in an environment very different from that of just 10 to 15 years ago. While this observation seems obvious in today's fast-paced financial world, many monetary policymakers around the world are still under the influence of monetary theory that was developed with a much more structurally closed financial environment in mind. Revolutions in telecommunications and information processing have dramatically lowered the costs of acquiring and processing information. Not only are information costs lower, but the quantity of information has greatly increased, and it is available both more quickly and continuously, 24 hours a day. This has helped to dramatically increase the knowledge and sophistication of market participants, although they have had to wade through a huge amount of useless noise as well.
One implication of these lower costs of information processing is that risk assessment is nowcheaper. This in turn has spawned such financial innovations as the securitization of corporate and mortgage lending, which was followed by automobile lending, credit card receivables, and commercial leasing. Computer record keeping enables financial institutions to bundle a portfolio of small-denomination loans and sell them to a third party, earning fees for doing so. Computer technology also enables financial institutions to tailor these loan packages so they produce payment streams in forms desired by the market. Securitization in effect transforms loans into securities and promotes the integration of the loan and securities markets. Such developments have important implications for the banking industry and consequently, for the transmission mechanism of monetary policy.
Lower information costs, however, have much broader implications than integrating loan and security markets. Computer technology, for example, has fostered the development of program trading, which involves computer-driven trading between stock index futures and the stock price index. Such trading is synonymous with sophisticated arbitrage operations between future and spot equity markets; that is, to the intertemporal integration of equity markets. Lower information costs, therefore, constitute a force working to integrate financial markets that previously were more segregated. Computers and the Internet have also empowered individuals to bypass financial institutions in the trading and investment process.
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