This is one point I keep emphasizing, monetary policy is most effective when the central bank signals future policy intentions; movements in the fed funds rate only matter to the extent that they signal future policy intentions. This means that when the central bank appears to be “doing nothing” it actually might be quite active. The old Keynesian economics of the liquidity trap, which implicitly underlies all arguments for fiscal stimulus, is predicated on the assumption that a sort of singularity is reached when nominal rates hit zero. They can’t be lowered, and political pressure makes increases unlikely during periods of high unemployment. So (the argument goes) fiscal policy multipliers can be calculated under the assumption of “other things equal,” i.e. no monetary policy sterilization. But that’s not how things work in the real world. As soon as a massive fiscal stimulus is passed, and conservatives start worrying about inflation, then central banks start chattering about exit strategies. This chatter is monetary tightening, just as surely as a rise in the fed funds rate. We are always in the classical world, there is no Keynesian world....
“The announcement effect has displaced the liquidity effect as the fulcrum of monetary policy implementation,” the economists wrote. When it comes to the U.S. central bank, “on many occasions, moving the federal funds rate appears to have required no, or almost no, central bank transactions at all”–the market did the Fed’s work for it, the paper stated.
Friday, July 30, 2010
Five Second Sumner: Silence as Effective Monetary Policy
Sumner explaining it well: