Monetary Theory Question
There has been a lot of drama among monetary theorists in the blogosphere, and I have been waiting for Scott Sumner to join the fray. He writes,
Thus the question is never whether low rates unfairly subsidize borrowers, or whether high rates unfairly tax borrowers, because the Fed is not directly fixing interest rates, or driving any sort of tax or subsidy wedge between lenders and borrowers. Rates are set in the market. The question is whether the money supply is set at a level that produces the sort of interest rates, exchange rates, prices, NGDP, etc, that are consistent with optimal macroeconomic performance.
Read the whole thing, and follow the links if you need to get caught up on the controversies. As for where I stand, I will just say that I find the monetary theory of Sumner and Krugman more, um, familiar than those of Rajan and Kocherlakota.
Here is a multi-part question for monetary theorists:
Suppose that the ten-year interest rate on Treasuries is now 2.6 percent.
1. What open market operations would you recommend to try to bring this rate down to 2.5 percent as rapidly as possible?
2. What open market operations would you recommend to try to bring this rate up to 10.6 percent as rapidly as possible?
3. If someone were to recommend for both (1) and (2) open-market purchases of short-term Treasuries with high-powered money (not necessarily in the same amounts or over the same time period), could that be the right answer? Explain why or why not.