Nominal Anchor

Nominal Anchor

A government policy that provides stability to an economy at the expense of some of that government's autonomy. For example, if a government pegs its currency to another, it reduces the uncertainty in exchange rates but also gives the government less ability to combat inflation or otherwise change the money supply.
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"In our view, monetary policy is limited in Oman due to pegging of the Omani rial to the US dollar, although we note that the peg has provided a stable nominal anchor for the economy.
What matters is that monetary policy avoids second round effects to inflation by insuring strong nominal anchor."
It follows that in order to achieve nominal and real stability, a central bank must operate with a rule that provides for the stability of nominal variables (a stable nominal anchor) and that respects the working of the price system (allows market forces to determine real variables like the real interest rate and the unemployment rate).
Nevertheless, the countries' open economies with their easy flow of goods and labour have largely underpinned the fixed exchange rate as a credible nominal anchor. The monetary union that was initially envisaged for 2010 has been delayed in part because Oman and the UAE have opted out.
According to the ratings agency, exchange-rate pegs to the US dollar provide a credible nominal anchor, but imply a lack of independent monetary flexibility, and shallow domestic capital markets are also a rating weakness.
But having a nominal anchor is better than being entirely without one even if the anchor cable is pretty elastic.
Typically in transition economies, like Poland, the Czech Republic and Hungary, the monetary authorities initially adopted a hard peg--a fixed exchange rate, or heavily managed exchange rate, to provide a highly visible nominal anchor. In reality there was little choice.
Second, there must be something systematic in central bank procedures that ties down the way that the public forms its expectation of the future price level (i.e., provides a nominal anchor).
The most important task of monetary policy is to provide the economy with an anchor for inflation expectations--a nominal anchor. In Norway, monetary policy is oriented towards low and stable inflation with an annual rise in consumer prices of close to 2.5 per cent over time.
Inflation targeting and alternatively GDP targeting as a framework combine the advantages ascribed to discretion (that is, flexibility) with the advantages ascribed to rules (nominal anchor).
This view leads the authors to end their paper by stating that, "Given the central bank's commitment to price stability and its willingness to bind its policy to an intermediate target that serves as the nominal anchor for monetary policy, the choice between an inflation target or a monetary aggregate then is probably more a question of culture than economic principles." I agree.
At the same time, the fixed exchange rate can successfully act as a nominal anchor during macroeconomic stabilization.