ECB makes great conferences, I have been to a few but I missed this one titled The role of money: money and monetary policy in the twenty-first century . In the world based on web you can quickly catch on, as all papers and policy panel webcast are available. Some ten years ago I would make notes on paper while browsing the papers, nowadays I make notes on my blog, it comes more handy and also other people can benefit. So below you will see a one evening summary of what I have undestood from quick-reading of these important papers. If got something wrong I hope that someone will point it to me on this blog.
L. Christiano et al. “Monetary policy and stock market boom-bust cycle”
Boom-bust ccyle is triggered by a signal (eg. about improved productivity) that turns to be false after some time. But such models cannot replicate the magnitude of the actual swings. However if one introduces a Taylor-type monetary policy and sticky wages you convert what otherwise would be a mild volatility into booms and busts big time, and one can say that monetary policy is the chief villain behing output volatility. How it works? When agents receive signal about improved technology (think about intenet-type shock that allowed for economic blogs) cost of leisure becomes higher as one can make money working more productively. Normally sharply rising real wages would limit teh size of the boom. But when wages are sticky, the only wage to get higher wages is via lower inflation. But when centrral banks notices that inflation is heading below the target it lower rates to bring it back, which fuels boom even furher. When signal is reversed the big bust follows. Paper shows that when inflation is low but credit growth accompanies sharp asset price growth the welfare enhancing policy implies leaning against the wind, which implies tightening not easing. In short, inflation targeting without paying any attention to credti growth could aplify shocks hiting the economy and could be welfare reducing.
M. Woodford “Is money important for monetary policy?”
Woodford’s paper is very rich, it looks at varioos aspects of the role of money in the conduct of the monetary policy. Does ignoring money mean a return to high inflation period we have seen in 1970s? Are models without money inmplete or inconsistent? What is the long-run relationship between money and inflation, with ephasis on Gerlach (2003) “two pillar” Phillips curve which combines traditional Phillips curve inflation model (with output gap) in high frequences and money inflation relationship based on the quantity theory of money in low frequences (above 8-years). Woddford shows that you do not need money to model inflation, that cashless models can be consistent with money demand models of long-run money-inflation conitegration models (sorry about using economic slang). That even if there were a stable long-run relationship between money and inflation, central bank does not know what the money growth rate would be ion the long run, and often the recent period is a very poor predictor for the long run. Money is not exogenous to monetary policy, so it does not make sense to extract long-term trends and play with them, as trends can change woth policy changing. Woodford also dismisses the “two-pillar” Phillips curve models rightly noticing, that insignificant output gap in low frequences is a result of no variation in the output gap in low frequencies by construction. Woodford shows that you cannot improve inflation forecasts in two-pillar models by adding money. Woodford agrees that money could be useful indicator variable, but it would be highly dependent on the particular model used.
Paper concludes that rather than diverting resources to monetary analysis, central banks should put more efforts into improved modelling of price and wage dynamics, otherwise the likelihood of making policy mistakes will go up. So Christiano says go for credit or you risk creating booms and busts, while Woodford says there are better ways to utilize brain-power of central bank economists that play with money equations.If you are not economist and you read this phrase do not ponder, make an experiment and go to see two doctors when you feel sick, see what diagnosis you will get.
H.Uhlig in his discussion of above papers reiterates that New Keynesian models are monetarist indeed, that one should focus on cotrolling inflation and abandon using money which is confusing, and put more efforts into modelling inflation. He says that Christiano et al. are wrong, and shows several problems with their intuitive story.
There is also a paper by ECB head of research reviewing what has been the ECB experience with two pillar-strategy. It is very detailed and open (about expert corrections) and it argues that there is an infomational role in money about future inflation that goes beyond information contained in conventional economic variables.
M.Flandreau “A history of monetary targets 1815-2006″
Paper postulates that it is worth looking at two episodes of globalization, in 19th century and at present, and there is one major distintion, before central banks pursued exchange rate stability (external anchor) now they are focused at domestic anchor, inflation partly becasue we are able to measure it. But both today and 100 years ago there were similatr problems of rules versus discretion or the issue of independence, Paper is very informative and worth reading (together with M.Bordo discussion), but let me point to just one conclusion. Author says that debate whether low Great Moderation was achieved thank to good monetary policy or thank to globaloization os flawed, because history teaches us that the same forces bring about globalization and good institutions able to keep inflation low.
R.Caballero “The Macroeconomics of Asset Shortages”
The world has a shortage of financial assets amid excess demand for store of value and collateral by householdsw, corporations, governments, insurance companies, finanacial intermediares. It is a result of shocks (Japan – 90s, European stagnation – 90s, EMEs – 90s, oil – 00s) and structural changes (China, globalization, financial development, which is net collteral consuming). One of the problems that emerges is financial underdevelopment in increasingly important parts of the world. Emerging markets are important part of the story as they exhibit chronic asset shortages and behave in a coordinated fashion (in crisis together, fast growing together). Globalization allows for exporting local asset shortages (magnified by asset crashes such as Japan) to the world at large. Asset scarcity explain many phenomena: global imbalances, low interest rates (as a market mechanism to create additional assets), low inflation (as mechanism to increase valuation of existing scarce nominal assets). Forcing a decline in the value of scarse assets will futher magnify the problem of excess demand for assets, and lead to even higher excess supply of goods, with deflagtion to follow. So do not prick bubbles, learn to live with them, spread them, preserve value of assets. Best policy is to speed up financial market development in emerging markets. Paper ends with a very powerful statement:
“As for policy, perhaps the main advice is the importance of recognizing the source of these symptoms and the fact that some of them are simply the market’s attempt to fill the asset gap. In this context, knee-jerk reactions to the emergence of speculative bubbles and global imbalances can be dangerous and counterproductive. The world already paid dearly during the 1970s for failing to identify the nature of the shock that had just hit the world economy. Let us hope we do not repeat the mistake, this time around by failing to identify the shortage of assets as the root cause of the seemingly puzzling recent macroeconomic developments. “
I skip non-paper presentations in thius summary, also becasue after quick-reading papers for the past few hours I feel exosted. But let me add few comments on my own. Papers address very important issues and several messages should be heard:
- those who defend the role of money is the monetary policy should try harder
- instead of plugging money into our thinking we should put more emphasis on understanding prices and wage formation and the role of expectations in these processes. Monetary policy is about managing expectations (which requires independence, accountability, transparency, excelent communication), it does not not call form money in our models
- History repeats itself, and we should not limit ourselves to the analysis of the loast 20 years, maybe last 200 years would be more appropriate. As shown by Bordo, Fillardo (2005) periods of deflation and inflation are equally typical, and 1970-80s high inflation period appears to be an outlier not a rule in the longer period;
- Central bank sould do their job, which is keep inflation low and stable, and Kohn’s extra action policy should be implemented with an extreme caution, as it can do more harm than good.
- This is partularly important if Caballero story is a correct one, but I can’t tell if this is the case, but I like his story.
- Finally, I think that this money “come back” to economic models is a fad, or a fashion. Firstly, studies on global inflation show, that money matters for inflation in a way that is meaningful for monetary policy only on the global level (i.e. global money growth explains global inflation). So as long as we do not have a global central bank or a global monetary policy coordination we should not get too excited about using money. Secondly, the amount of innovation taking place in payment systems will in the next few years destroy any relationship between money and inflation that may be sqeezed from the data today. So I expect that debate about a need of using money in monetary policy formulation will be raplaced by a need to take into account transactional innovations.
Few years ago I would spend lonely evening (my wife in on a business trip to China, and kids are sleeping) watching TV and enjoying a glass of Pinot or Cabernet Sauvingnon. But after discovering Web 2.0 I enjoy writing blogs much more, especially when it comes with a glass of red wine.