Approaches to monetary policy
There are three general approaches to monetary economics, according to Scott Sumner:
- Old Keynesianism: Money supply data is uninformative and monetary policy is often ineffective. Old Keynesianism is popular when inflation is so low that nominal interest rates fall close to zero. In that environment, one often sees large increases in the monetary base coinciding with very low inflation.
- New Keynesian: Money supply data is uninformative and monetary policy is highly effective. New Keynesianism is most popular when inflation is at moderate levels and fairly stable, say from 1983 to 2007. During these periods, there is little correlation between money growth and inflation, mostly because inflation is quite stable.
- Monetarism: Money supply data is informative and monetary policy is highly effective. Monetarism is most popular during periods of high and unstable inflation, such as the 1970s. During those periods, there is usually a close correlation between long run money growth rates and inflation.
Why do macroeconomists keep changing their model?
By: Scott Sumner – George Mason University
Which type of monetary policy stabilizes or destabilizes the economy?
This is the question that Robert Hetzel asks in this essay. He compares the Fed’s reaction to the COVID pandemic, which he refers to as activist monetary policy, to the Volcker-Greenspan neutral monetary policy.
The activist monetary policy was predominant in the 1970s and aimed at aggregate demand management. In the late 2010s and early 2020s the Fed adopted the activist monetary policy and rejected the opportunity to raise the funds rate preemptively to preserve price stability, while through quantitative easing, it created an enormous amount of money by monetizing government debt. In the 1970s this policy, argues Hetzel, was destabilizing since the temporary reduction in unemployment from monetary stimulus gave way in time to a sustained increase in inflation.
The Volcker-Greenspan neutral monetary policy, on the other hand, concentrated on achieving low trend inflation and abandoned any attempt to lower unemployment by exploiting the inflation-unemployment tradeoffs promised by the Phillips curve.
The holy grail of monetary economics is to identify a rule for monetary policy that stabilizes the economy. However, identifying such a rule is inherently controversial. The reason is that one has to assess the nature of the shock that accompanies periods of instability.
[…]The future behavior of the economy will provide evidence about the optimal policy. If the activist policy was appropriate, by year end 2022, inflation will be on the way back down to 2 percent with an unemployment rate remaining near 4 percent. If the nonactivist policy would have been better, inflation would remain near double digits and would recede only with a recession.
Learning from the Pandemic Monetary Policy Experiment
Author: Robert L. Hetzel
From: George Mason University
