Thursday, September 17, 2009

Should Monetary Policy "Lean or Clean"?

That is the title of a new paper by William White, one of the few influential economists who saw the crisis coming and tried to warn others. Here is the abstract:
It has been contended by many in the central banking community that monetary policy would not be effective in "leaning" against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in "cleaning" up (the bust) afterwards. In this paper, these two propositions (can't lean, but can clean) are examined and found seriously deficient. In particular, it is contended in this paper that monetary policies designed solely to deal with short term problems of insufficient demand could make medium term problems worse by encouraging a buildup of debt that cannot be sustained over time. The conclusion reached is that monetary policy should be more focused on "preemptive tightening" to moderate credit bubbles than on "preemptive easing" to deal with the after effects. There is a need for a new macrofinancial stability framework that would use both regulatory and monetary instruments to resist credit bubbles and thus promote sustainable economic growth over time.


  1. I vote "Clean"

    Keep nominal expenditure on a 3% growth path. If central bankers want to nag people about borrowing or lending too much or else investing or lending into a speculative bubble--fine. But keep the quantity of money growing with the demand to hold money and the market interest rate equal to the natural interest rate.

    Similarly, if an asset bubble or credit bubble pops, keep nominal income growing on its growth path. If the demand for money grows a remarkable amount, inrease the quantity of money to match. If the natural interest rate (partiularly the short term, low risk version) drops to what seems to be absurdly low levels, well that is exactly where the market interest rate needs to be.

  2. But keep the quantity of money growing with the demand to hold money and the market interest rate equal to the natural interest rate

    Alfred Marshall: "Money thus is truly a paradox - by wanting more, the public ends up with less, and by wanting less, it ends up with more"

    the money supply can never be managed by any attempt to control the cost of credit

  3. Monetary policy is a mess if the FED's research staff doesn't publish meaningful statistics.

    And no one can deduce anything when the FED overlays (wipes out) the old data.

    Take 1980 for example. The St. Louis FED displays a declining rate of change for the total non-seasonally adjusted data.

    The Board of Governors shows that legal reserves remained flat for 1980.

    But the real data shows an 11% annual rate-of-change in legal reserves. I.e., the data was wiped out.

    Then the conclusion ends up being that Paul Volcker followed a tight monetary policy when in fact Volcker followed a very easy money policy. History was re-written.