Does Monetary Policy Affect Real Economic Activity? [FED CAN'T HELP THE ECONOMY]

Cato Journal ^ | Spring/Summer 2016). | Jerry L. Jordan

[expat_panama]

Do the policy actions of monetary authorities actually affect economic activity? We know that time and other resources are expended, but what can we observe about the results of such efforts? In answering this question, it is helpful to begin with an account of how monetary authorities in discretionary, fiat currency regimes are traditionally thought to influence economic activity. Here, every college course in intermediate monetary theory tells essentially the same story. A nation’s money supply comprises two distinct components: paper currency and deposits at banking organizations. The former was the largest component in earlier times, but the latter has come to dominate in recent decades—at least in most countries. The deposits in banks are subject to minimum reserve requirements, and the total deposit liabilities of banks constitute some multiple of reserve balances (that is, vault cash plus deposits at the central bank). The banking system as a whole is thus “reserve constrained,” which means that, unless the central bank provides more reserves, there is an upper limit to the total deposits that may be held by individuals and businesses. By extension, if currency outstanding increases, and the central bank fails to add to the total supply of reserves available to private banks, then there has to be a corresponding contraction of deposit money. These reserve constraints have historically meant that, for better or worse, monetary authorities have the power to control the nation’s money supply, and, in so doing, affect economic activity.

However, this traditional account no longer holds true. The commercial banking system has ceased to be reserve constrained, and this means that monetary authority actions to change the size of the central bank balance sheet do not affect the nation’s money supply. Now, instead of being constrained by the amount of reserves supplied by central banks, banking companies are constrained by the supply of earning assets that are available to them. And it is the supply of these earning assets that, subject to capital constraints, determines banks’ aggregate deposit liabilities.

[snip]

Conclusion

For several years, major central banks have pronounced that the objective of massive quantitative easing was to raise the inflation rate. That objective has not been achieved despite the quadrupling (in the case of the United States) of the central bank balance sheet. Because commercial banks are no longer reserve constrained, the historical linkage between the central bank balance sheet (the monetary base) and the outstanding money supply has been broken. Changes in the size and composition of the central bank’s assets and liabilities are thus unrelated to the amount of money in circulation. Without the ability to influence the supply of money, central bank open market operations have no influence on the rate of inflation. Announced changes in the federal funds rate therefore have no implications for economic activity, or the rate of inflation.

If inflation should emerge, central banks will have no tools for countering the pace at which the purchasing power of money declines. In the early stages of past periods of accelerating inflation, central banks mistakenly expanded their balance sheets as they “leaned against” the trend of rising nominal interest rates, failing to see that an “inflation premium” was being incorporated by both lenders and borrowers. In other words, monetary authorities’ policy actions were “accommodative” of rising prices. For the foreseeable future, however, no such accommodation will be necessary. Ballooning central bank balance sheets are more than sufficient to fuel extreme rates of inflation without further debt monetization. This is not a forecast that inflation will in fact occur. It simply is a statement of the new reality: whether or not there is inflation is unrelated to anything central banks do or do not do.

[expat_panama]

mho is that the writer may have erred in saying that the Fed's goal was creating an inflation that never came. The hard facts are that in late 2008 we had deflation, then the Fed acted and then deflation stopped and we've had low inflation ever since.

What that says to me is that whether we thank the Fed is up for debate but we did get what we wanted...

[cp124]

Fed is for Wall Street. The government and elites could care less about Main Street.

[ctdonath2]

A headline with a binary “yes/no” question is always answered “no”.

Of course monetary policy can affect the economy, but assuming the goal is general good the practical answer is no.

The best that can & should be done is maintain a stable money supply, keeping pace with population & GDP growth such that the purchasing power of a currency unit does not change. Anything else iss ultimately disruptive & damaging.

[expat_panama]

 

Good morning along w/ a new month, a new quarter, plus the downhill half of 2016!

Yesterday stock indexes powered up big time in rising trade making it our IBD 'follow-thru' day and an uptrend resumes.  Still, they recommend a caution that futures traders echo (some up some down). Meanwhile precious metals soar to new highs w/ gold - silver up to $1,335.25 - $19.28!

Today's big reports are ISM Index, Construction Spending, with Auto and Truck Sales.

My news-link picks:

The 'College Ed Haves' Have Taken All The New Jobs - Lisa Du, Bloomberg
4 Questions to Ask Before Selling Your Stocks - Eric Nelson, Seeking Alpha
Brexit Now Has Business Voting With Its Feet - Ben Marlow, The Telegraph
Hillary Wants Sequel To Failed Stimulus - Stephen Moore, Weekly Standard
There's No End to Lois Lerner's Lawlessness - Editorial, Investor's Business
Taxes on Sugary Drinks Slim Wallets, Not Waists - Michelle Minton, USAT
Populism Is Clouding Europe's Future - Byron Wien, The Blackstone Group
The Non-Existent 'Social Costs' Of a Gold Standard - Nathan Lewis, Forbes
The Risk/Reward Equation Has Changed - Macro Man

[palmer]

We had a blowout commodity bubble in 2008.

If that was inflation then the deflation (bubble popping) was normal and as healthy as we can get considering the unhealthy bubble. That was followed by deleveraging which sometimes is called deflation but is not.

[proxy_user]

This is a pretty tough article for the average Freeper. Everyone should read it, but I’m not sure everyone has the background to follow the arguments.

[Wpin]

The Fed has done a fantastic job of keeping this economy reasonably afloat. It is ridiculous to present that it cannot affect (do good) for the economy...historical data is overwhelmingly in support of the Fed’s good actions helping strengthen the economy.

[Pelham]

I agree with what you have said here.

The monetary easing, the QE, was to prevent a deflationary collapse of the money supply similar to what triggered the Great Depression.

This was seen as a very real possibility as a trillion dollars in mortgage based ‘assets’ on the books of banks suddenly was exposed as liable to vanish.

[Pelham]

In addition I’m not sure that the author really knows his subject. Currency is a microscopic portion of the money supply. And I’d like to see he his evidence that banks are no longer reserve-constrained. I’m not buying that claim.

[MosesKnows]

Does Monetary Policy Affect Real Economic Activity?

Yes; but isn't the real question whether it effects economic activity in a positive or negative way.

To put it another way; can the government centrally plan and control the (fill-in-the-blank, economy, health care delivery, education, society, or rights) better than the market for fill-in-the-blank, economy, health care delivery, education, society, or rights?

I say no, what say you?

[expat_panama]

The best that can & should be done is...   ...that the purchasing power of a currency unit does not change.

That's impossible.  Life is change and as long as human beings buy and sell there will be price changes (AKA changes in purchasing power).  On the Planet Earth all we can do is set a goal (say, inflation below 2%) and do what it takes.  What we're seeing is that the Fed's doing that job fairly well.

[expat_panama]

economic activity...   ...can the government centrally plan and control the (fill-in-the-blank...   ...what say you?

If we "fill-in" the blank w/ "regulate the value of the dollar" then the answer's yes.  With that other stuff it isn't "no", it's "hell no!".

[expat_panama]

...historical data is overwhelmingly in support of the Fed’s good actions helping strengthen the economy...

A lot of folks at the Fed have said that the best (and only) way they can help the economy is w/ stable prices.  That may not be the popular line and it may not even be a consensus there but it's what I personally can sign on to.

[expat_panama]

...QE, was to prevent a deflationary collapse...

Huh, so I'm not the only freeper that says that. 

 

tx!  I don't feel so lonely now...

[ctdonath2]

Sorry, I assumed “within reason” would be understood.

Kinda hard to achieve encyclopedic thoroughness when posting on a cell phone.

[central_va]

The 16th amendment needs to be repealed, the federal reserve dissolved, the income tax eliminated and a 25% across the board tariff put in place.

[babble-on]

Jerry Jordan was a good FOMC member. Miss his sane and commonsense approach to monetary policy.

[babble-on]

Yes, QE was necessary to prevent a depression, but not sufficient to create a sustained recovery.

The big problem is their tolerance of the asset bubbles, and not really their reactions to the bubbles’ collapses.

[MosesKnows]

"regulate the value of the dollar"

Point well taken.

Perhaps I should have phrased it differently.

To put it another way; can the government CONSTITUTIONALLY centrally plan and control the (fill-in-the-blank, economy, health care delivery, education, society, or rights) better than the market for fill-in-the-blank, economy, health care delivery, education, society, or rights?

[expat_panama]

agreed. very much so.