The monetary economics of the 2040s, today
By Scott Sumner
When I engage in monetary policy research, I try to write papers that will seem persuasive in the future. That may not always be a wise decision, and indeed back in the 1980s, some of my colleagues suggested that I might be better off doing more conventional research, instead of writing papers advocating the targeting of NGDP futures prices.
What was conventional monetary economics during he 1980s? I recall lots of papers such as “Money Demand in Turkey”, or “Money Demand in South Korea.” Today there is a lot less interest in studying money demand, perhaps because the topic doesn’t seem that useful in a world where central banks do not target the money supply (nor is the money supply determined by factors such as the gold stock.) Today there are lots of papers that use interest rates as an indicator of monetary policy, perhaps because central banks target interest rates.
A few weeks back, Tyler Cowen linked to a NBER paper by Claudia M. Buch, Matthieu Bussiere, Linda Goldberg and Robert Hills that tried to measure the international transmission of monetary policy. But what is monetary policy?
We also consider two commonly used alternative measures of the monetary policy stance. The first is the actual short term policy rate, defined in first-difference form in order to account for changes in the policy stance. For the US, the effective federal funds rate (FFR) is a typical measure. The rate used should represent an average funding cost for banks. The second measure is the degree of quantitative easing (QE) capturing the volume of central bank liquidity provision such as the change in the central bank’s balance sheet relative to GDP.
Apart from the choice of the proxy for the monetary policy stance, the issue of identification of monetary policy shocks arises. Otherwise, the sensitivity of banking variables to the policy measure is polluted by the effects of the variables to which policy rates respond. Identification of monetary policy shocks has, arguably, been one of the most contentious issues in the macroeconomic literature, and we cannot settle this debate here.
While the authors admit that identification is a tricky subject, it does not stop them from pursuing their research on the international transmission of monetary policy.
I believe it should have stopped them. The problems are so great that any study of monetary policy using interest rates to identify policy shocks is unreliable. Interest rate-oriented monetary studies are today’s version of the money demand studies of the 1970s and 1980s.
I would encourage younger academics to avoid doing research in areas that are currently popular, and instead try to focus on areas that will be popular in about 30 years. In 1986, I thought that the futures targeting approach would be the wave of the future, and so far I’ve been wrong. But hope springs eternal, and I continue to believe that this approach will catch on at some point in the future.
How about the identification of monetary policy? If there are any readers who still believe that interest rates are a good way of identifying changes in monetary policy, I encourage you to read the literature on NeoFisherism. Not because I believe the NeoFisherians are correct (I think they are wrong), but rather because the rise of the NeoFisherian view clearly suggests that there is something profoundly wrong with the tendency of mainstream economists to equate low interest rates with easy money.
If interest rates are a dead end, what will replace this variable? I can’t be sure, but my own preference is to use expected NGDP growth (currently 4.6%) as an indicator of the stance of monetary policy (currently expansionary). I’m not confident that NGDP growth will be the accepted indicator of the 2040s, but I am confident that the money supply (widely used as a policy indicator in the 1980s) and the nominal interest rate (widely used today) will both be thoroughly discredited within 30 years.
If you plan to do research on the impact of monetary policy on some other variable(s), then please pick a monetary policy indicator that other economists are not using. Better to aim high and end up an unconventional academic failure like me, rather than have a modest success writing papers that no one will care about in 30 years.
PS. Note that the traditional interest rate policy indicator has led some pundits to conclude that US monetary policy has recently tightened, whereas the NGDP growth indicator more accurately points to a recent easing of policy.