Monetary policy

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Monetary policy is what the Federal Reserve hopes they are doing with all of those nifty printing presses. Reality, such as the banking crisis sometimes reminds the Fed of exactly how far off they sometimes are. The exact goal of monetary policy depends on the central bank, but policy is typically directed at two things; unemployment and inflation. The fact that the Fed accomplishes this by mixing fractional-reserve banking with money printing has a tendency to drive those with a limited grasp of abstract concepts into a frenzied stupor. Being in a stupor may seem at odds with being frenzied, but, trust me, there are no higher brain functions happening there.

How does it work?[edit]

There are a lot of nifty theories trying to answer exactly that question. The short wrong answer is; it doesn't quite work, but we get it close enough. The long wrong answer is; we change how much money is printed, and the real interest rate adjusts accordingly, until the price level catches up to it. If we print more money, real aggregate demand increases for at least a little bit, encouraging an expansion of business. The problem is that businesses would love to raise prices in order to soak up more profits from this extra demand. If firms could choose whatever price they wanted, they would set their prices just high enough to soak up the aggregate demand created by printing extra money. In this scenario, monetary policy would only serve to increase the rate of inflation. However, it is believed that a host of issues makes prices somewhat difficult for firms to change (a concept referred to as sticky prices), implying that there is some room for monetary policy to boost aggregate demand. Of course, actually modelling sticky prices requires some hand wavy simplifications, making it a rather contentious issue among experts who study it. It is important not to confuse these debates with the stark raving mad garbage spewed on libertarian economics forums: the economists debating this issue are interested in identifying how monetary policy works, not assuming they already know.

Variants[edit]

There are a number of proposed and existing methods by which monetary policy is conducted around the world.^[1]

Rule Based[edit]

Rule based monetary polices are narrowly defined terms of engagement banks are allowed to utilize to achieve their goals. Some examples include

• Taylor Rule: Named after economist John Taylor, the Taylor rule sets up a simple mathematical formula to grow and contract the money supply in response to changes in the Federal Funds Rate.^[2] Where r is the Federal Funds Rate, p is the rate of inflation over the past four quarters, and y is the output gap.

• Price Level Targeting: A policy rule that seeks to target an average rate of inflation over some long time horizon. If a central bank has a 2% target, they have to compensate for periods of time when inflation is below 2% by raising it above 2%. Similarly, if inflation gets too high they have to lower it to compensate and bring the long run average back to 2%.
• Friedman K% Rule: Named after Milton Friedman, the K% rule mandates that the base money supply most grow at a constant rate indefinitely. Friedman preferred this be undertaken by a computer program, not a central bank.
• McCallum Rule: An augmented version of the K% Rule, the McCallum rule, named after economist Bennet McCallum, includes a number of additional variables to tweak the designated desired growth rate in base money.
• Gold/Commodity Standard: The government sets the price of money equal to some commodity such as gold, silver, or both. This ties the price level to the world's supply and demand for gold.
• NDGP Targeting: The central bank targets a stable rate of nominal income growth. Some have argued the central bank should buy and sell nominal income futures until the futures market predicts(equalizes) the bank's target.^[3]

Non Rule Based[edit]

These tend to be how banks operated before the 1980s and 90s, with less clear obligations and guiding principles.

• Discretionary: The central bankers are free to manage the economy by whatever means they see as best.
• Constrained Discretion: The central bankers have some mandate to follow(say 2% inflation and full employment) but are more or less free to achieve it however they see best.
• Free Banking: Private banks can issue their own currency. Most proposals for free banking aren't totally free, and mandate a gold standard on the side.

How it doesn't work[edit]

Several popular anti-semitic conspiracy theories^[Who?] based on racist stereotypes have cropped up to explain exactly that the Fed is involved in the following:

• Selling you into Jewish slavery
• Transferring your property into Jewish control
• Ensuring your government is firmly within Jewish clutches

The evil Jewish slave state involves low unemployment, stable inflation, easy access to the funds needed to start a business or go to school, and delicious bagels.

Challenge[edit]

Try to enforce monetary policy, exchange rate policy and an open capital policy all at once, and let us know how it goes.

See also[edit]

• Economics
• Tax
• Federal Reserve

References[edit]