Saturday, January 26, 2013

A market monetarist talking about the ZLB and normal vs. alternative monetary policies!


It will be interesting to see if Sumner endorses this or accuses him of thinking monetary policy is useless... I'm guessing he won't do the latter in the case of fellow market monetarist. I'm not sure if he'll do the former.


  1. I don't see anything in that post which contradicts market monetarist orthodoxy. Market monetarists generally realize that if you are using interest-rate targeting as your policy instrument, you risk hitting the ZLB which is exactly why interest-rate targeting is a bad idea.

    The solution proposed by that post is: "A possibility is simply to state that if interest rates hit zero then the BoK will switch to a Singapore style monetary policy, where the central bank conduct monetary policy through the exchange rate channel."

    This is what Switzerland started doing and which Scott Sumner, has been praising as an example of good monetary policy. (even if of course NGDP targeting would be better)

    1. Right! I'm of the view there's not much friction with market monetarism either.

      Sumner often seems to act like there is friction when certain people talk like this, IF they happen to also advocate fiscal stimulus (which of course Lars isn't). In other cases, he doesn't seem to have a problem with people talking like this.

    2. Honestly, I have started thinking the distinction between monetary and fiscal policy isn't very clear. If the Fed targets the short-term interest rate, any issue of new government debt will provoke the Fed to buy that debt to defend the interest rate. Unless of course we are at the ZLB in which case, the extra government debt is basically identical to new currency being issued. And Scott Sumner's reductio ad absurdum regarding liquidity traps is basically advocating that the Fed do stuff which we generally call fiscal policy. (buying stuff with freshly-printed money to make the price level rise)

      There are good institutional reasons, I think, for the Fed to handle demand shortfalls and not get Congress involved, but I think it's about time we dumped the distinction between monetary and fiscal policy with regard to counter-cyclical policy. It's all monetary policy except when it's all fiscal policy.

      And while I'm on my high horse, it's also about time people stop fighting about demand shortfalls vs supply shocks vs capital structure. I have yet to see any explanation as to why all economic downturns would have to be caused by one of those. There is no reason why different downturns could not have different explanations. At the end of the day, supply shocks, demand shortfalls and misallocated capital can all potentially mess with us and the right policy is the one that prevents all three problems. There are policy arrangements that can help keep all three at bay.


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