A recent opinion piece in the Herald, pitting Don Brash and Brendan Doyle in to debate the issue of monetary policy was good. They seemed to agree that, ultimately, any issue is one of the real exchange rate – which is due to real economy factors. A point I’ve heard a number of times before
However, all this debate reminds me of a speech by Bernanke back in the day. The choice quote:
Although a strict rules-based framework for monetary policy has evident drawbacks, notably its inflexibility in the face of unanticipated developments, supporters of rules in their turn have pointed out–with considerable justification–that the record of monetary policy under unfettered discretion is nothing to crow about. In the United States, the heyday of discretionary monetary policy can be dated as beginning in the early 1960s, a period of what now appears to have been substantial over-optimism about the ability of policymakers to “fine-tune” the economy. Contrary to the expectation of that era’s economists and policymakers, however, the subsequent two decades were characterized not by an efficiently managed, smoothly running economic machine but by high and variable inflation and an unstable real economy, culminating in the deep 1981-82 recession. Although a number of factors contributed to the poor economic performance of this period, I think most economists would agree that the deficiencies of a purely discretionary approach to monetary policy–including over-optimism about the ability of policy to fine-tune the economy, low credibility, vulnerability to political pressures, short policy horizons, and insufficient appreciation of the costs of high inflation–played a central role.
Is there then no middle ground for policymakers between the inflexibility of ironclad rules and the instability of unfettered discretion? My thesis today is that there is such a middle ground–an approach that I will refer to as constrained discretion–and that it is fast becoming the standard approach to monetary policy around the world, including in the United States
“Constrained discretion” is (arguably) very much the flexible inflation targeting framework we use now – the determination to “fine tune” is one that is coming out increasingly, and is based on an illusion of understanding and control regarding the macroeconomy (that and a few fallacious ideas of how things have panned out ).
No-one is arguing against having a further look at financial regulation, and trying to understand what has happened there. However, this provides no case for messing around with the way the RBNZ performs monetary policy and the existence of a floating exchange rate – and in their determination to “do something” there are a set of politicians, journalists, and other analysts/economists trying to take us down a dark path.