Here is a quote from a random article from the financial media in 2008:
“Central banks around the world are rapidly depleting their ammunition as interest rates head to unparalleled lows”
It is quite common that it is claimed that central banks around the world are out of ammunition because interest rates are close to zero and that there therefore are no more options for monetary stimulus. Market Monetarist obviously disagrees strongly with that assessment, but we are up against a long running tradition.
Lets jump into a time machine and fastback to 1935. This is US congressman T. Alan Goldsborough supporting Federal Reserve chairman Marriner Eccles in Congressional hearings on the Banking Act of 1935:
Governor Eccles: Under present circumstances, there is very little, if any, that can be done.
Congressman Goldsborough: You mean you cannot push on a string.
Governor Eccles: That is a very good way to put it, one cannot push on a string. We are in the depths of a depression and… beyond creating an easy money situation through reduction of discount rates, there is very little, if anything, that the reserve organization can do to bring about recovery
There is now doubt that even in 1935 the situation was quite desperate, but not as desperate as it was before the US went off gold in 1933.
So further back to 1932.
In 1932 the US economy is deep in depression, unemployment is massively high and deflation has never been stronger.
The situation is desperate for president Hoover. No matter what ideas he comes up with nothing works and he stands no chance of winning the upcoming presidential elections.
The chairman of the Federal Reserve Eugene Meyer is telling Hoover that he should use fiscal policy to boost the economy, but that monetary policy loosening is no option.
We need a little be more sci-fi: Everybody in 1932 knows the reputation of Gideon Gono as a money printing psycho central banker.
So what happened when Gono is beamed back to 1932? Well, everybody knows that he doesn’t care about any strings on money policy – he just print money like a mad man and everybody knows that he created hyperinflation in his previous job. So what would you expect? They would of course expect inflation! And they would expect the US to give up the gold standard very fast – after all Gideon Gono is not exactly Bob Murphy. And he probably would so with in minutes of arriving back in 1932.
What happens now? Everybody realise that the value of cash will not continue to increase so there will be no reason to hoard cash. Rather suddenly the dollars are burning holes in people pockets. And the same goes for banks and corporations: We don’t want dollar anymore. This is the hot potato effect in monetary theory. Money demand collapse relative to the money supply. That is monetary loosening!
So monetary policy works with long and variable LEADS – in fact with time warping leads.
Fast forward to 2011. The global economy is on the verge of a new depression – the talk of a debt-deflation continues nearly four years into the Great Recession. An economics professor Scotty starts blogging about monetary policy. His big hero is Gideon Gono – the Fed chairman who in 1933 pulled out the US from the Great Depression and with it the rest of the world. Nobody would remember Hitler and we would still be talking about the “Great War” rather than World War 1.
And no Gideon Gono was never a good central bank and he would probably have stolen the US gold reserve once he landed back in 1932. This is not an endorsement of inflationist policies or insane central bankers, but an illustration of the importance of what expectations mean for monetary policy effectiveness.
PS after Gideon Gono became Fed chairman Hoover won the presidential campaign and became the longest serving US president ever and became a much loved president in the Republican party. They call him: “The president who understood monetary policy”. And the Republican party is forever grateful to Hoover for never having introduced Social Security. And most important Paul Krugman would look pretty stupid when he went on and on about the liquidity trap.
PPS luckily Gideon Gono was not beamed back to 1979.
PPPS If you want to read a truly insane book on monetary policy have a look at Gideon Gono’s “masterpiece”: Zimbabwe’s Casino Economy: Extraordinary Measures for Extraordinary Challenges.