Monetary Policy over 50 years

BundesBank celebrated its 50th anniversary by hosting a conference titled ‘Monetary Policy over 50 years’. I covered Mishkin’s paper he presented at the conference here .

Lars Svennson, Deputy Governor at Riksbank and professor at Princeton University, has given a speech on the same topic. It is more or less on the lines of Mishkin’s paper but has some more insights.

He begins with Milton Friedman.

In economic research, 50 years is a long time. I will actually start in 1967, with Milton Friedman’s presidential address at the meeting of the American Economic Association, so I will only cover about 40 years.

He discussed what monetary policy cannot do, what it can do, and how monetary policy should be conducted. Regarding what monetary policy cannot do, he noted that it cannot in the long run control real variables such as unemployment and GDP; it can only control nominal variables, such as the exchange rates, the price level, or mone-tary aggregates. These insights were not obvious at the time, but they are now part of the conventional wisdom.

What have been the broad ideas economists have learnt since then?

  • Target money – too difficult to target the price level
  • Monetary targeting failed, but inflation targeting has worked fine
  • Better knowledge about the transmission mechanism
  • Monetary aggregates matter little for monetary policy
  • The importance of the institutional framework
  • Taylor rules are robust but often overemphasized and misunderstood

What do we need to work upon?

  • I believe that it is desirable to do flexible inflation targeting more explic-itly
  • Regarding the ongoing discussion about the role of asset prices in monetary pol-icy, I believe we know enough to state that asset prices should not be targets of monetary policy. As long as their development is not a threat to financial stability and the payment system, they are relevant for monetary policy only as indicator variables, that is, only to the extent that they contain some information about the future target variables (inflation and resource utilization).  However, if credit or asset-price developments indicate threats to financial stability or the payment sys-tem, this may impose restrictions on the normal conduct of monetary policy and also require special actions

All is pretty standard stuff except the last point. Riksbank has for a long time defended the fact that Central banks need to only look at inflation. However, there recent mon pol reports have mentioned importance of housing prices which has been criticised as well in Mishkin’s reporton Riksbank. Ingves, Governor, Riksbank also agreed to this in his recent speech at Kansas Fed.

The question is when do you decide asset markets can lead to financial stability. Take this sub-prime crisis. All along Fed said it is within control and then suddenly came the rate cuts and the analysis that all was not well. I am expecting more research on the same in future.

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