Monetary Policy Since the Great Inflation

(cc photo by LateNightTaskForce)

Allison Schrager’s defense of central bank independence seems like an excellent occasion to launch an argument I’ve been cooking up. She concludes with this:

It’s fair to question how independent and long-term minded the Fed really is. In the last few decades the Fed was quick to aggressively cut rates during a recession to prop up a flailing economy. Yet there existed an asymmetry with this policy. When the economy grew very fast the Fed did not increase rates to match. It suggests central bankers (who know better) wanted to provide an economy with all upside and no downside: like politicians. Nonetheless, even if flawed, Fed independence remains a crucial component to a healthy economy. We saw this week how hard it is to push even mildly stimulative fiscal policy through Congress. You can you imagine what would happen if we let them have a direct hand in monetary policy too.

But okay. Say we start in 1980 and try to draw a list of times developed economies have fallen into recession. Call this the “too tight” list. Now lets try to draw a list of times developed economies have had bouts of inflation. Call this the “too loose” list. The too tight list is going to be way, way, way, way longer than the too loose list, which I believe would consistent almost entirely of France in the early Mitterand years.

I think it’s perhaps time to consider the possibility that monetary policy has been systematically too tight in the developed world for the past 20 years. I think it’s pretty commonplace to observe that policy in general tends to kind of swing form overreaction to overreaction. So in the 1930s we had a Great Depression. That led to an expansionary bias that led to a Great Inflation in the 1970s. It seems plausible to think that the pendulum swung in reaction toward unduly tight policy. And what would we expect to see if policy had become too systematically too tight? Well, we’d expect real GDP growth to slow down relative to where it had previously been (check), we’d expect working class wages to stagnate (check), and we’d expect to see countries with less inflation to also experience slower real growth, which is exactly what you see if you compare the US to Europe to Japan.

The political right is normally associated with argument for tighter money, of course, but I think conservatives should consider embracing this conclusion. For one thing: I think it’s true. For another thing, if it’s true then it provides a solution to middle class wage stagnation that’s much, much, much more “free market” than the alternatives you’re likely to hear from Jacob Hacker, Paul Pierson, Paul Krugman, Bernie Sanders, etc.