For readers who are unfamiliar with Market Monetarism I have a number of pieces of research that I would recommend, but everybody should start out by reading Robert Hetzel’s excellent and truly thought provoking paper “Monetary Policy in the 2008–2009 Recession”
Here is the abstract:
“The recession that began with a cyclical peak in December 2007 originated in a combination of real shocks because of a fall in housing wealth and a fall in real income from an increase in energy prices. The most common explanation for the intensification of the recession that began in the late summer of 2008 is the propagation of these shocks through dysfunction in credit markets. The alternative explanation offered in this article emphasizes propagation through contractionary monetary policy. The first explanation stresses the importance of credit-market interventions (credit policy). The second emphasizes the importance of money creation (money-creation policy). According to Federal Open Market Committee (FOMC) Chairman William McChesney Martin, “The System should always be engaged in a ruthless examination of its past record” (FOMC Minutes, 11/26/68, 1,456).”
Hence, Hetzel’s view is that the 2008-9 recession primarily was a result of excessively tight US monetary policy. Scott Sumner puts forward the same story and here I would especially recommend reading “The Real Problem Was Nominal”.
Robert Hetzel has a book in the pipeline on the Great Recession. I am sure it will change the way we all look at events since 2008.
Marcus Nunes
/ October 4, 2011A sure road to doom: Taylor Rule for policy prescription and Credit View of the transmission mechanism!
Bill Woolsey
/ October 4, 2011Thanks for the link, Lars.
I wish Hertzel would see the light on a target growth path for nominal GDP.
I _like_ all the business about the natural interest rate.
Using the GDP gap to judge appropriate changes in the policy rate, then at the zero bound swtich to M2 targeting, with M2 being made “high” relative to GDP until policy rate comes off the zero bound seems a bit vague.
Is the problem with NGDP growth path targeting is that it requires “too much” response to changes in headline inflation?
Lars Christensen
/ October 4, 2011Bill, I personally is somewhat skeptical about Hetzel’s focus in the natural rate as I do not believe it is possible to measure it and fundamentally there is a risk that focus becomes a focus on the level of rates rather than on whether monetary policy is tight or loose.
So agree with Marcus here – Hetzel’s focus is quite close to a Taylor rule, which I fundamentally has failed as a proper concept for monetary policy guidance.
Operationally I think monetary policy is conducted better by selling and buying for example t-bills or using the exchange rather than by controlling the price of overnight credit (interest rates).
Marcus Nunes
/ October 4, 2011Maybe somebody could come up with a “fun theory” that would give the correct motivation for monetary policy. For pointers, check this out: