This is a startling note from Daniel L. Thornton of St Louis Fed.
He questions efficacy of monetary policy in raising output and employment. He compares the mon pol trajectory in 1990s with 2000s. Research shows policy rates were tight in 1990s and easy in 2000s:
A norm that is commonly used to evaluate the stance of monetary policy is the natural rate of interest—the interest rate that would prevail if the economy were in equilibrium. The nominal interest rate is composed of the real rate of interest, which is independent of the stance of monetary policy, and the expected rate of inflation, which is determined by monetary policy. The equilibrium real interest rate is not observable, but a commonly used estimate is 2 percent.
The FOMC made an effort to reduce the inflation rate beginning in the late 1970s. By late 1991 the inflation rate had fallen to under 3 percent and had stabilized considerably. By 1993 six central banks had adopted numerical inflation targets and it was widely believed that the FOMC had an implicit inflation objective in the range of 1 to 3 percent. The FOMC has recently removed the ambiguity by adopting a 2 percent long-run inflation objective. In any event, the natural nominal interest rate is frequently assumed to be 4 percent.1 The chart shows the FOMC’s funds rate target relative to the natural rate since 1990; the vertical line denotes June 2001. The chart suggests that monetary policy was tight during most of the period from January 1990 through June 2001 and easy during most of the period since.
This should imply growth rates should be lower in 1990 and higher in 2000s. Right? Wrong!
Given the marked difference in the stance of monetary policy over these two decades, one might expect to find a similar marked difference in economic performance. The top table shows the average growth rate of real GDP, the unemployment rate, and inflation over the past two decades. The first column presents the average of these variables for the entire period, the second removes months or quarters of recession, and the third removes the effect of the financial crisis from the second period by ending the period in June 2007. Output growth was twice as high during the period when monetary policy was tight than when it was easy.
Some of this difference is due to the fact that the 2007-09 recession was more severe and protracted than the 1990-91 and 2001 recessions. When the recessions are accounted for, the difference is much smaller. The difference is not improved, however, if the period of the financial crisis is removed.
The unemployment rate is higher during the easy policy period; however, all of the difference can be attributed to the financial crisis and its aftermath. The average unemployment rates for 1990-2001 and 2001-07 are essentially the same. Absent recessions and the financial crisis the stance of monetary policy appears to have had essentially no effect on output growth or the unemployment rate.
What is even more interesting is impact on inflation:
More surprising is the fact that the marked difference in the stance of policy over the two decades had little effect on the average inflation rate of inflation. The average inflation rates were essentially the same whether the recession months were removed or second period ended in June 2007.
One possible explanation for these facts is policymakers were more concerned about inflation during the first decade and more concerned about output growth and the unemployment rate during the second.
Fed’s focus on growth in 2000s seems to be true as per his research.
The short analysis has interesting take aways:
The fact that there is little difference in economic performance during the past two decades despite a marked difference in the stance of monetary policy is consistent with the theoretical and empirical evidence that monetary policy has no permanent effect on real variables and with skepticism about the efficacy of the interest rate channel of monetary policy more generally.
It also raises a question about the possible effectiveness of the FOMC’s commitment to maintain the funds rate target at zero through late 2014.
Interesting contrarian approach to efficacy on mon pol. Something Milton Friedman might approve strongly. This shows as long as inflation exp. are anchored, a central bank cannot really do anything to change output/employment.
