Should Monetary Policy Be More Expansionary?

Martin Wolf: 

Is monetary policy too expansionary or not expansionary enough?:

People with a free-market orientation believe that the economy has a strong tendency towards equilibrium. Over the long term money is “neutral”: a rise in the money supply merely raises the price level. In the short term, however, monetary policy may have a big impact on the economy. A big question, however, is over how to measure the impact of monetary policy in an environment such as the present one, when short-term interest rates are close to zero and the credit system is damaged.

The difficulty arises because of the huge divergence between what is happening to the monetary base (the monetary liabilities of the government, including the central bank) and what is happening to broader measures of money (principally the liabilities of the banking system). The former has exploded. But the growth rate of the latter is extremely low. …

The … inflationary impact of “money printing” can … only happen if the overall money supply starts to grow rapidly. This is not now happening. Only the monetary base is expanding rapidly. Should such a broader expansionary impact emerge, monetary policy will have been successful, the central bank can then raise rates, thereby preventing a rapid growth in credit and so constraining the growth of broad money.

My conclusion is that what is happening to the balance sheet of the central bank is unimportant, except to the extent that it has prevented a collapse of credit and money. What matters is the overall supply of credit and money in economies. This continues to be stagnant in the developed world. Concern about an imminent outbreak of inflation is consequently a grave mistake. To the extent that there is a danger of “monetization” of debt, it will emerge only if we fail to return to growth, because that is the situation in which it is most likely that public sector deficits will fail to close. It follows that strong monetary tightening now may increase the long-term threat of inflation, rather than reduce it.

What do you think?

There is no evidence of worry over the threat of inflation in financial markets. To repeat a point that’s been made here many, many times, increasing interest rates too soon would be a mistake since it will make it more difficult for the economy to recover. If anything, given the weakness that still exists in the economy, more ease is called for.

Originally published at Economist’s View and reproduced here with the author’s permission.
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