In my previous post Nick raises an interesting question:
What you are proposing is, I think, methodologically equivalent to “event studies” in financial markets. We take a very narrow window of time, so narrow that we can reasonably hope that nothing else changes except the policy announcement.
But suppose you lived in a world where everybody had been taught Keynesian (or RBC) economics at school. I wonder how NGDP and RGDP futures markets would respond to monetary policy announcements then?
I believe they’d react in exactly the same way as if they’d been taught market monetarism. Markets ignore conventional wisdom and react on the basis of how the world actually works. Some examples:
1. Conventional wisdom in 1933 said leaving the gold standard was a very bad idea. That’s what people had been taught. But the actual decision to leave the gold standard sharply reduced risk spreads in the corporate bond market, and sharply raised equity prices. Both market reactions (correctly) pointed to much faster growth ahead.
2. In March 2009 the conventional wisdom was that the Fed was out of ammo and was pushing on a string. This meant that QE would not affect market prices. But markets understand market monetarism, and the dollar fell 6 cents against the euro on the day QE1 was announced.
3. People are taught that easy money lowers interest rates. Markets know better. In January 2001 and September 2007 announcements of a dramatic easing of policy raised longer term rates. In December 2007 an unexpectedly contractionary announcement caused stocks to crash, and interest rates fell from 3 months to 30 years. The markets know that Keynesian interest rate theory is wrong. Like Nick Rowe, they know that the IS curve often slopes upward.
4. The yen recently plummeted on rumors of Japanese monetary easing, despite most people being taught Japan was in a liquidity trap.
I’ m not saying markets are always right. The world is highly complex and market participants don’t always know how policies will impact the economy. Especially new and untried policies. But for the most part they ignore what they were taught in school and react as if they are all market monetarists.