Why is Nick Rowe so incredibly clear on monetary policy?

Here read this:

Yes, if the central bank raises or lowers interest rates, this will affect financial markets. But I thought we had gone beyond thinking of monetary policy in terms of raising or lowering interest rates. Or buying or selling bonds in an open market operation. Or raising or lowering the money supply. Or raising or lowering the exchange rate. Those aren’t monetary policies.

Targeting 2% inflation is a monetary policy. Keeping the money supply growing at 4% per year is a monetary policy. Keeping the exchange rate fixed at $0.95US is a monetary policy. Targeting “full employment” (at least, trying and failing) is a monetary policy. Following the Taylor Rule is a monetary policy. Targeting a 5% level-path for NGDP is a monetary policy.

Yes.  Exactly.  When monetary policy rules are analysed by economists this is clearly kept in mind – but when it comes to discussing it to the public we feel compelled to “tell a story” that involves whatever people are interested in.  And this confusion, although it may not have caused the crisis, hasn’t helped matters.

And why is he so clear on it, he understands the way that policy has been framed differs from the truth of what monetary policy is as a targeted rule:

OK, this is probably the weirdest post I have ever written. I am going to argue that interest rate targeting is not what central banks really do; it’s a social construction of what they really do. Interest rate targeting is not reality, it’s a way of framing reality.

That was weird enough, but I’m now going to get really weird. The failure of monetary policy is not caused by anything central banks are actually doing; it’s caused by central banks’ way of framing what they are doing, and by the rest of us accepting that same framing. The current recession was caused by those (and that includes especially central bankers themselves) who think that central banks use an interest rate as the control instrument. It’s the framing of what central banks do that caused the mess, not anything central banks are actually doing. The social construction of reality is what dunnit!

Monetary policy is about expectations, and using rule based policy to help manage these expectations, take advantage of any perceived tasty looking trade-offs, and deal with “time inconsistency”.

Interest rates, exchange rates, asset prices, are all factors that help give us information about the stance of monetary policy (relative to some prior belief, or some set of expectations).  But monetary policy is about the rule, and being clearer about this rule and what it means instead of making “neat little (partial) causal stories, that only work part of the time” is a good way to go.

Don’t get me wrong – I believe strongly in the intertemporal substitution justification for active monetary policy.  But the interest rate can only be interpreted with prior assumptions around a bunch of other things, and that point is often lost.

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