Thursday, September 15, 2011

Goal displacement in monetary policy

This based on a comment I made here.

Here are, as commenter Mark A Sadowski suggests, some "words to live by":
Moral: Inflation is not the greatest economic evil, and absolute price stability is not the greatest economic good.
In considering money and monetary policy, one should always remember to ask the question: what is money for?

The short answer is: to make transactions easier, to reduce transaction costs (for both on-the-spot and across-time transactions). The notion that "price stability" at the cost of pushing transactions seriously below trend is some advance is a classic piece of goal displacement.

This is what makes targeting money GDP/Py make so much sense (the goal of the "Market Monetarists" as Lars Christensen names the new macroeconomics school in his useful summary paper [pdf] and which I have argued for on expectations grounds). It is the monetary authority aiming to optimise money's performance of its central purpose--to lubricate transactions: both immediate and cross-temporal transactions. Even better, it is using a goal which provides a clear empirical evidence about whether it is doing that or not (and so, as Joshua Hendrickson points out, making the central bank far more accountable).

Lowering inflation from 13% to 4% in the "Volcker Transition" is one thing. Lowering it from 3% to 0% while pushing transactions seriously below trend and creating a much worse economic downturn is quite another. What do the people who preside over such an outcome think money is for? What do they think they are for?


  1. It is an irresponsibility that no one is responsible for but that we will all pay for. What is the alternative???

  2. A large question. Some think the solution is to abolish central banks: a big call. Others think the gold standard: a deeply daft idea (as this paper [pdf] provides a salutary warning about). In terms of practical politics, the Joshua Hendricksen piece I linked to in the post seems to me the way forward.