What is monetary policy?
By Scott Sumner
When I use the term ‘monetary policy’ it refers to actions taken by the monetary authority aimed at influencing the supply or demand for base money, with the ultimate objective of influencing a broader set of macro variables, such as inflation or NGDP growth. I don’t like it when people mix up monetary policy with other policies, such as banking regulation. On the other hand the dictionaries don’t seem to agree with me. Jared Pincin sent me this definition from the Merriam-Webster dictionary:
“measures taken by the central bank and treasury to strengthen the economy and minimize cyclical fluctuations through the availability and cost of credit, budgetary and tax policies, and other financial factors and comprising credit control and fiscal policy.”
I often argue that monetary policy is about money, not credit. And that it is very different from fiscal policy. On the other hand I don’t make the rules. If this is the definition of monetary policy, then so be it.
But in that case we have a crying need for a new term. We need a term for the thing that I have always thought of as being monetary policy. Mr. Boehner is not engaged in targeting inflation at 2%. Nor is Senator Reid. You can’t target inflation at 2% by adjusting capital requirement for banks, or placing limits on subprime mortgages. Regulations can impact the real quantity of lending. But who is going to control the nominal quantity of lending? (It would be very interesting to get data on the nominal and real quantity of bank lending during the Zimbabwe hyperinflation. I suspect they differed quite a bit.)
Inflation targeting requires continual adjustments in the supply and demand for base money. We need a term for those policies. A better solution would be to retain my preferred definition of monetary policy, and then call all policies aimed at impacting aggregate demand (including demand-side fiscal policies) “nominal policies.” The aggregate demand curve could be called the nominal spending curve, in which case it would be a rectangular hyperbola.