Explaining unconventional monetary policy using the car/highway analogy

Economists love for using cars/highways as analogy is well-known. Whenever it is difficult to explain a concept they usually try and find an analogy in car/highway (see this for one example).

Adam Posen, now Bank of England MPC member uses the same analogy to explain unconventional monetary policy. A shortened version of the speech is also available in a eurointelligence article here.

He says:

I give the analogy that normal monetary policy by interest rate setting is like driving a new Range Rover down the M4 on a commute: one knows how long it will take to get to the  desired exit; the ride is smooth, well-marked and familiar; any particular causes of delays beyond normal traffic are clearly visible and swiftly cleared. Unconventional monetary policy, including QE, is like making the same trip but: doing so in an urgent hurry; driving a 10 year old used Vauxhall Vectra with a cranky transmission; down a rural road because the M4 is closed; without a good map or signage, and with all kinds of strange surprises blocking traffic. You will get where you are going using QE, but you are not sure how long it will take to get there, and you will not enjoy the ride. In other words, we can be confident that the coefficient of QE’s effect on nominal income is positive, and therefore that the British economy would have been stuck in a far worse place had QE not been implemented, but we cannot pretend to have precise knowledge of the size or timing of QE’s impact.

(In the article he replaces  class=”hiddenSpellError” pre=”replaces “>M4 with autobahn and Voxhall Vectra with Opel Vectra).

It is always humbling to read Posen’s excellent work and this speech is also a very good one. He says the real concern is not inflation but banks able to allocate funds to the economy. He actually rubbishes that high money now would lead to inflation later. He points to various charts showing episodes of high money growth have hardly led to inflation. High money only led to inflation in 1970s but there were other reasons for the rise in inflation then (see this St Louis Fed publication for a lot of details on the inflationary episode of 1970s)

 He then points to close parallels of UK economy with Japan’s in 1990s and says main worry is Banking system. It is not as bad as Japan as policies in UK have been better, but there is a parallel. So, the recovery is going to be weak and slow.

Excellent stuff as usual. Very good references at the end as well.

One Response to “Explaining unconventional monetary policy using the car/highway analogy”

  1. Jo Says:

    Nice fluffy analogy – delightful nonsense. No one knows the outcome of this form of QE….no one.

    This was merely a ‘do not panic travellers, your captain has full control of the aeroplane’ piece.

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