Monday, August 09, 2010

The impotence of monetary policy

This post by Krugman sums it up. It's a pity things are even worse than he suspects:
A problem with the current BOJ policy, however, is its vagueness. What precisely is meant by the phrase “until deflationary concerns
subside”? Krugman (1999) and others have suggested that the BOJ quantify its objectives by announcing an inflation target, and further that it be a fairly high target. I agree that this approach would be helpful, in that it would give private decision-makers more information about the objectives of monetary policy. In particular, a target in the 3-4% range for inflation, to be maintained for a number of years, would confirm not only that the BOJ is intent on moving safely away from a deflationary regime, but also that it intends to make up some of the “price-level gap” created by eight years of zero or negative inflation.

BOJ officials have strongly resisted the suggestion of installing an explicit inflation target. Their often-stated concern is that announcing a target that they are not sure they know how to achieve will endanger the Bank’s credibility; and they have expressed
skepticism that simple announcements can have any effects on expectations.
OK, so say the BOJ or Fed announce a higher inflation target. Now what? Inflation means higher price levels, and for a price, you need a transaction. Announcing a target does not create a transaction, and therefore, does not influence a price. The BOJ's concerns that their credibility is on the line are right on -- the standard monetary mechanism (overnight interbank interest rates) has no impact on prices.

Unconventional monetary mechanisms, like changing other rates, have no impacts for the same reason. The only thing that has impact are transactions, a transfer of nominal assets from the Govt to the non-Govt sector. And this is fiscal policy, not monetary policy.

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Blogger Musgrave said...

In addition, the whole idea of announcing a higher inflation target so as to induce people to spend (else inflation eats away at their savings) strikes me questionable if not unfair. Put another way, I see nothing wrong with the standard MMT idea, namely ensuring the private sector has the stock of net financial assets it wants. Once the private sector has the latter, it will spend.

Of course there is the problem that in Japan that stock is much higher than elsewhere, which in turn might lead to the claim that if the Japanese all decided to blow their cash savings at once, hyperinflation would ensue. But then if everyone in any other country decided to blow their cash savings at once, the same inflationary result would ensue.

3:58 AM  
OpenID noumignon said...

Announcing a target does not create a transaction, and therefore, does not influence a price.

You're taking as a premise "only things that create a transaction can influence a price?" So, say, announcing that the Fed was going to destroy all paper currency not invested in the stock market wouldn't influence the price of stocks? I hope I made up a silly enough example for you to feel you're being caricatured.

7:26 PM  
Blogger winterspeak said...


That's a very fair example.

Now, please tell me how exactly the Fed will destroy all paper currency. Send out men in grey suits with flame throwers?

The Fed is limited to swapping assets, not asset creation or destruction. It sets interest rate exactly through a swap mechanism, changing the composition (term) of outstanding Treasury assets, not the quantity. For the Fed to start impacting quantity, it would need to arrogate fiscal policy, not monetary policy. And traditionally fiscal policy rests with Congress and the Treasury.

1:40 PM  
Blogger Warren Mosler said...

a monopolist can simply raise price.

saudis could simply reprice their crude higher

and mainstreamers believe inflation is a function of inflation expectations, so price could just be marked up as indifference levels changed due to expectations.

they believe this because they don't realize the currency itself is a (simple) public monopoly, making the price level ultimately a function of prices paid by govt when it spends (and/or collateral demanded when it lends)

Warren Mosler

6:47 PM  
Blogger winterspeak said...


1. Welcome!

2. Not sure how your comments are directed towards. But, if mainstreamers start to spend as a consequence of reacting to a higher inflation target by the Fed, once again, the mechanism is actual prices via transactions.

If those bids don't appear, or appear and aren't taken, then you don't get the price shift despite the Fed "setting expectations". And the Fed's ability to impact prices via expectations is blown up.

I think Nick Rowe spoke about the Fed's influence as being fundamentally illusory, but he meant this in a good way and thought it was a feature, not a bug ; )

Govt spending, and therefore the prices Govt pays for this, in my mind is fiscal policy.

3:47 PM  
OpenID Ohm said...

Inflation expectation does create more consumption now -- unless we are talking hyperinflation say, 15% or more OR we are talking Big Ticket items like houses. You are not going to buy an extra T shirt that you don't need today because it will be 4% more expensive next year. But yeah, if you believe that a $500,000 house will cost 4% more tomorrow, and you do plan to own one next year, then you might prepone the timing.

From another angle, targetting an inflation rate is so convoluted. IMO, the only way in which inflation can be considered good is when it's a bi product of evening out of wealth and income distribution, which again points to Fiscal policy.

10:00 PM  
OpenID Ohm said...

Oops, i meant to start:
"Inflation expectation does *not* create more consumption now -- unless we are talking hyperinflation expectation say, 15% or more..."

11:51 PM  

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