Why is inflation so stable?

Three different people directed me to a Robert Barro column that asks how the Fed achieved its recent success in inflation targeting:

Judging by the US inflation rate over past decades, the Fed’s monetary policy has worked brilliantly. Annual inflation has averaged only 1.5% per year since 2010, slightly below the Fed’s oft-expressed target of 2%, and has been strikingly stable. And yet, the question is how this was achieved. Did inflation remain subdued because everyone believed that anything significantly above the 1.5-2% range would trigger a sharp hike in the federal funds rate?

Barro discusses research by Emi Nakamura and Jón Steinsson in the Quarterly Journal of Economics, which finds evidence that “a contractionary monetary shock – an unanticipated rise in the federal funds rate” – reduces inflation, but that significant effects occur only after 3-5 years.  And there’s an even greater mystery in this study:

Although unexpected increases in the federal funds rate are conventionally labeled as contractionary, Nakamura and Steinsson find that “forecasts about output growth” actually rise for the year following an unexpected rate hike. That is, a rate increase predicts higher growth, and a decrease predicts lower growth. This pattern likely occurs because the Fed typically raises interest rates when it gets information that the economy is stronger than expected, and it cuts rates when it suspects that the economy is weaker than it previously thought. . . .

[T]he puzzle is how the Fed can keep inflation steady at 1.5‑2% per year by relying on a policy tool that seems to have only weak and delayed effects. Presumably, if inflation were to rise substantially above the 1.5-2% range, the Fed would initiate the type of dramatic increases in short-term nominal interest rates that Volcker carried out in the early 1980s, and these changes would have major and rapid negative effects on inflation. Similarly, if inflation were to fall well below target, perhaps becoming negative, the Fed would sharply cut rates – or, after hitting the zero-lower bound, use alternative expansionary policies – and this would have major and rapid positive effects on inflation.

According to this view, the credible threat of extreme responses from the Fed has meant that it does not actually have to repeat the Volcker-era policy. Rate changes since that time have had modest associations with inflation, but the hypothetical possibility of much sharper changes has remained powerful.

Frankly, I am unhappy with this explanation. It is like saying that the inflation rate is subdued because it just is.

Some economists believe that fiscal policy determines the inflation rate. For that group, the answer to the question in the post title is simple: Since 1990, Congress has been taken over by a set of economic geniuses, who have deftly steered fiscal policy in a way that keeps inflation close to 2%, something not seen in earlier periods of history. (Inflation averaged near zero under the gold standard, and was very erratic on a year-to-year basis.  It averaged far above 2% during 1966-90.)

Barro and I prefer a monetary explanation for inflation.  His textbook entitled “Macroeconomics” provides what I regard as the clearest and most elegant model of important nominal variables such as the price level and interest rates.  (At least the best model at the first year econ grad student level.)  He does a beautiful job discussing money neutrality and super-neutrality.  He argues that changes in the price level are best modeled in terms of changes in the supply and demand for base money.  That’s also my preference.

His textbook model shows how the Fed could control prices by adjusting the supply of base money and, after 2008, also the demand for base money (via changes in IOR.)  Thus in a technical sense there is no mystery at all.  The Fed adjusts the base and IOR as needed to stabilize inflation at close to 2%.  The fact that the Fed uses interest rate targeting is a mere technical detail—prior to 2008 they adjusted the fed funds rate by moving the supply of base money.  In Barro’s model, it is the supply and demand for base money that matters.

So where is the “mystery” that Barro refers to?  I see two possibilities:

1. The Fed’s monetary instruments have behaved in an unusual fashion in recent years.  The relationship between the base and the price level is much weaker than before 2008.

2. The long lags identified by Nakamura and Steinsson raise the question of how the Fed knows where to set their policy instruments today, in order to hit inflation goals 3 to 5 years into the future.

Obviously these two issues are related.  If base velocity is unstable, or if the natural rate of interest is unstable (or both), it’s not at all clear how the Fed is able to figure out where to set their instruments today in order to achieve their long run policy goals.

My best guess is that the Fed relies on the following three assumptions:

1. Stabilizing the future expected price level goes a long way toward stabilizing near-term inflation.  As an analogy, imagine the government wanted to stabilize the price of gold, but its only tool (digging new gold mines) took 3 to 5 years to implement.  Could they stabilize current gold prices, with such long lags?

The answer is probably yes, as even stabilizing expected gold prices 3 to 5 years in the future will tend to stabilize current gold prices.  No one would sell gold for $800 or buy gold at $1200 today if they thought the government would move gold prices to $1000 in 4 years.  The same applies to the overall price level, which depends heavily on the future expected price level. (This is not just my view, but also the implication of more sophisticated macro models.)

That still doesn’t answer Barro’s question, but it gets us part way there.  There are two more components:

2. The Fed reacts to previous misses in its target, with easing or tightening of monetary policy.

3. The Fed also pays some attention to market forecasts, which provide additional policy guidance, beyond recent macro data.

Think of a ship captain steering a tanker across the ocean, toward NYC.  Even if the captain is relatively clumsy, and doesn’t have a very good idea as to how much to adjust the steering wheel when he gets off course, he should be able to eventually reach NYC under these conditions:

1. He knows where NYC is.

2. He knows which way to turn the wheel when he gets off course.

3. He has enough power to overcome wind and waves.

Central banks generally have enough power to steer nominal aggregates, even at the zero bound.  (Although there may be a few cases where they do not, due to strict constraints on what they can buy at the zero bound.)  They know which way to adjust monetary policy when they get off course.  And they have a 2% inflation goal and know when they have gotten off course.

The tendency of the current inflation rate to be heavily influenced by the future expected price level makes inflation relatively inertial under an inflation-targeting regime (but not under a 1970s-type regime).  And because of this inertia, even relatively “clumsy” central bankers can target inflation fairly effectively, because they can eventually get the price level back on course.  Greenspan was viewed as a “maestro” for his policy successes, but other central banks did roughly as well after 1990, a sign that it was the new inflation targeting regime, not the skill of the leader, that was decisive.

The ship analogy actually understates the ability of central banks to control inflation.  In the world of sailing, trend reversion does not reduce the severity of wind and waves.  But in the world of monetary economics, a credible policy of stabilizing long run inflation tends to reduce “shocks” such as fluctuations in velocity and or the natural rate of interest.  The better they do their job, the easier the job gets.

The head of the Australian central bank has an easier job than the head of the Japanese central bank, a country where previous tight money mistakes led to deflation that reduced velocity and the equilibrium interest rate, necessitating far more drastic actions by the BOJ today.

PS.  I did not discuss the real growth puzzle in the Nakamura and Steinsson study.  I suspect that Barro is correct that it reflects policy responses to expected future changes in growth.  Indeed we are seeing something like that today, with likely rate cuts in anticipation of slower growth ahead.  This is part of the broader “identification problem” in monetary economics, aka “never reason from a price change”.

HT:  Nicolas Goetzmann, Ramesh Ponnuru, Stephen Kirchner


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26 Responses to “Why is inflation so stable?”

  1. Gravatar of Benjamin Cole Benjamin Cole
    9. July 2019 at 16:56

    The tendency of the current inflation rate to be heavily influenced by the future expected price level makes inflation relatively inertial under an inflation-targeting regime–Scott Sumner.

    I wonder about this.

    1. Are not most economic actors price-takers? So they take today’s price—they do not raise it a little bit every day, or quarterly, based on future inflation outlooks. I might believe inflation will rise 3% annually. but there is little I can do to change the market that sets the price on my good or service.

    2. In terms of expectations, the financial media has been in recurrent hysterics about the prospects for higher inflation for the last 40 years—this was a dominant theme on WSJ op-ed pages. I realize the public is not the financial media, and yet the only literate media (about the central bank) has often predicted higher inflation.

    3. Indeed, even macroeconomic luminaries such as Paul Volcker and Martin Feldstein (now deceased) have for decades predicted higher inflation rates. I guess the fiscal theory of the price-level people must be certain higher inflation is around the corner.

    Yet inflation has been on a secular glide path lower since about 1980, and globally too. The public globally expected lower inflation?

    I think present inflation rates must have a lot to do with present aggregate demand and supply. Central banks have succeeded in limiting aggregate demand to a level that inflation is contained. The public, even the most literate public and informed public, may have expected higher inflation, but no one could execute on their expectations. The demand was not there.

    Of course, as George Selgin has pointed out (with his crop-bust in an agriculture economy example), we can see inflation as measured from supply constraints, even with a steady monetary policy.

    West Coast property owners may not expect future general inflation, but the demand for housing allows rapid rent increases—due to supply constraints. This reality increases the general inflation rate, as measured.

    The world’s major central banks made inflation-fighting the war they wanted to win, from about 1980 on. Sheesh, even in 2007-8, minutes of Federal Reserve Board meetings show hundreds and hundreds and more hundreds of mentions of the word “inflation.” It seemed an obsession.

    So central banks won that war—but they do not know what to do next.

    Money may be long-term neutral, but we know decades can pass as economies prosper or suffer due to poor monetary policies, such as the Great Depression or lost decades in Japan.

    Worse—if central banks can say must limit public expectations of future inflation, then no matter how low inflation is, they can always tighten. “We cannot let the inflation cat out of the bag.”

  2. Gravatar of Paul Paul
    9. July 2019 at 17:28

    “The fact that the Fed uses interest rate targeting is a mere technical detail—prior to 2008 they adjusted the fed funds rate by moving the supply of base money.”

    Before 2008, the Fed announced its target rate, which markets would instantly follow. The changes in the supply of base money, which are completely endogenous, come after.

  3. Gravatar of ssumner ssumner
    9. July 2019 at 17:43

    Paul, Sure, markets are efficient. But the market interest rate only changes because they expect the base to adjust appropriately. There’s no “magic wand” controlling rates.

  4. Gravatar of Paul Paul
    9. July 2019 at 18:55

    But the Fed cannot (or rather, will not) set the monetary base independently. Given that it will always supply whatever reserves the banking system demands at the given interest rate, talking about the monetary base just isn’t helpful.

  5. Gravatar of Paul Paul
    9. July 2019 at 19:00

    But the Fed cannot (or rather, will not) set the monetary base independently. Given that it will always supply whatever reserves the banking system demands at the given interest rate, talking about the monetary base just isn’t helpful.

  6. Gravatar of ssumner ssumner
    9. July 2019 at 20:29

    Paul, It’s helpful if you want to understand how monetary policy affects inflation. It’s not helpful if you want to understand what the Fed is targeting.

    And of course the Fed can target the base if they want to, that’s what QE does, and reverse QE.

  7. Gravatar of Paul Paul
    10. July 2019 at 04:01

    Scott, you can’t understand how monetary policy affects inflation if you don’t look at the target. The Fed always moves an interest rate, they just change that rate to meet their ultimate inflation target. And since we now see that even a fourfold expansion of the base can lead to inflation below the target, a focus on the base and the quantity theory of money is becoming useless at this point.

    QE may have targeted the monetary base, but it proved horribly ineffective at inflating the price level or NGDP. And I’m not convinced that, had they come out and announced that the Fed was using QE to target 5% nominal GDP instead of 2% inflation, it would have caused consumers and businesses (most of whom don’t even know what FOMC means) to turn on the spending jets.

  8. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    10. July 2019 at 05:58

    https://worthwhile.typepad.com/worthwhile_canadian_initi/2013/01/the-bank-of-canadas-success-and-failure.html
    https://www.aeaweb.org/articles?id=10.1257/aer.104.7.1942

  9. Gravatar of LK Beland LK Beland
    10. July 2019 at 06:08

    Yes, the rate of inflation has been remarkably stable since 2010.

    Interestingly, the rate of total wages growth (number_of_employees*hours_per_week*average_hourly_wage) has also been very stable since 2010, by historical standards:

    https://fred.stlouisfed.org/graph/?g=mJie

    (btw, note the almost perfect monetary offset in 2013–fiscal cliff, but the slightly imperfect offset of 2018–Trump tax cut)

    In my opinion, this makes the Fed’s performance even more astonishing. It’s hitting both mandated targets (inflation and employment) quite well. How can this be? Are labor/aggregate wage expectations and inflation expectations stabilizing each other?

  10. Gravatar of ssumner ssumner
    10. July 2019 at 08:44

    Paul, It’s completely meaningless to discuss whether “QE works” without some context. Otherwise it’s merely reasoning from a quantity change. It’s as silly as talking about whether low interest rates “work”. How’s Japan doing with 25 years of low rates?

    Almost all the studies I’ve seen suggest that QE was more effective than cutting interest rates, once they had fallen to near zero in the US. But to be most effective it needs to be part of an effective regime, such as NGDPLT, or at least PLT.

    And the fact that central banks often target interest rates tells us precisely nothing about whether rates are an important part of the monetary transmission mechanism. The Singapore central bank targets exchange rates, and does perfectly fine.

    LK, The Fed seems to be gradually learning from past mistakes, which is what you’d expect of a skilled organization with independence.

  11. Gravatar of Paul Paul
    10. July 2019 at 11:09

    Scott, all monetary arrangements ultimately come down to changing interest rates. Even if you believe that expectations of future nominal magnitudes are the heart of the transmission, something besides expectations has to change (else there’d be no reason for expectations to change). I don’t see how a NGDP level target would cause higher demand on its own unless the CB had the ability to move the price level – which it almost never does.

    QE was a debt management operation, swapping interest-bearing reserves for interest-bearing bonds. The only way that a big time expansion of bank reserves will cause inflation is if the injected reserves caused an expansion of the broad money supply, which could then lead to more spending. That only happens if you believe, wrongly, that banks multiply reserves into broad money via a stable “multiplier” mechanism.

    CBs also can’t target exchange rates without moving interest rates.

  12. Gravatar of ssumner ssumner
    10. July 2019 at 19:47

    Paul, You said:

    “Scott, all monetary arrangements ultimately come down to changing interest rates.”

    That’s like saying “All monetary arrangements come down to changing the price of zinc.” It’s true that all monetary policies of any size will affect the nominal price of zinc, but so what?

    Or how about “All Fed policies come down to changing the exchange rate between the US dollar and the Norwegian krone.”

    You said:

    “CBs also can’t target exchange rates without moving interest rates.”

    Yes, and they can’t target interest rates without moving exchange rates. So what?

  13. Gravatar of Paul Paul
    11. July 2019 at 05:23

    Scott, you’re now talking about something which, as you know, is called the long-run neutrality of money. This is simply a theory about how changes in the quantity of money will affect prices in the long-run, and has nothing to do with the transition period to a new equilibrium which interests us.

    You have said in the past that permanent changes in the stock of base money will increase NGDP and also all nominal variables like inside money (that’s why you said the commercial banking system isn’t especially important). My question being, if changes in the stock of base money don’t transmit themselves fairly quickly to changes in inside money (which is what actually matters for most spending), why would NGDP or the price level change?

    “Expectations” is a weak channel when it’s the only thing at work. Something else has to change, or expectations will have no reason to change.

  14. Gravatar of Paul Paul
    11. July 2019 at 05:26

    That “something” could be interest rates, which I could definitely see mattering more to the average person than the quantity of money (which has no meaning to most people). But, empirically, interest rates aren’t very important for investment.

  15. Gravatar of Don Geddis Don Geddis
    11. July 2019 at 12:16

    Paul, you seem to be asking about what is the primary monetary policy transmission mechanism (aside from expectations). Scott’s answer is: the Hot Potato Effect. The public’s cash balances are in equilibrium with the price level, then the central bank forces larger cash balances on the public then they are willing to hold at the current price level. The attempt to “get rid of” excess cash balances raises velocity, and thus aggregate demand, and thus (typically) the price level.

    Bank lending and commercial interest rates are not a significant part of this monetary policy transmission mechanism story.

  16. Gravatar of Paul Paul
    11. July 2019 at 12:25

    Don, the central bank cannot “force” the public to hold any money it doesn’t want to hold, unless it gets rid of open market operations altogether and just does helicopter money (which would make it near impossible to institute a contractionary policy).

    Everyone who receives a cash balance from the central bank in an OMO had to be a willing seller of some asset. In a world where the money stock is endogenously determined, there is no hot potato/real balance/portfolio allocation effect.

    Discrepancies between the supply and demand for money balances are solved by changes in the supply, not the price level.

  17. Gravatar of ssumner ssumner
    11. July 2019 at 20:51

    Paul. So the easy money policy of the 1960s made interest rates go up, and the tight money policy of 1930 made interest rates go down. Explain how those changes impacted inflation.

    Regarding your final comment, consider the diamond market in order to see the fallacy of your argument. Suppose a vast new diamond mine is discovered, and the global market is flooded with new diamonds. Every single diamond buyer is a “willing buyer”, but that doesn’t stop the flood of new diamonds from reducing their value. The same is true of money. The value of money falls when the market is flooded, which means inflation.

  18. Gravatar of Paul Paul
    12. July 2019 at 12:36

    Diamonds are not money, Scott. There are not stocks of money, yet undiscovered, that can be unearthed and sent to market, because money is a good that can only be produced by banking institutions. Moreover, it cannot be sold to willing participants unless its price – the interest rate – changes. The CB has to lower interest rates in order to increase the demand for money, otherwise it cannot engage in an OMO.

  19. Gravatar of Matthias Görgens Matthias Görgens
    14. July 2019 at 01:30

    Paul, an OMO does indeed have a willing counterparty. But that doesn’t mean the willing counterparty wants to hold the money they got (at least not for long).

    Perhaps the opposite is easier to see: if the central bank starts selling off their balance sheet, they are also only dealing with willing counterparties. But it would be hard to argue that this would shrink the amount of money around.

    Or imagine a world with a central bank gold standard, and the central bank would buy and sell gold for dollars with willing counterparties. (Singapore and Hong Kong do something like that with foreign exchange.)

  20. Gravatar of Paul Paul
    14. July 2019 at 18:30

    Matthias, if your argument is that increases in the quantity of base money don’t have to follow the Cambridge k demand for money (to hold for precautionary purposes), sure. Money has many functions and people will use it.

    But how could that be the same for an open market sale, as you argue? If money is a useful good and people want it for many purposes, why would they ever choose to give it back to the central bank? The CB would have to change the interest rate, and this would only have an effect to the extent that interest rates mattered for aggregate demand (and they largely do not).

    It’s not a quantitative issue.

  21. Gravatar of Don Geddis Don Geddis
    15. July 2019 at 09:38

    @Paul: “There are not stocks of money, yet undiscovered”

    Yes, there are. The central bank can create new money, “by fiat”. (Hence the name, “fiat currency”.) So there are infinite stocks of money available.

    “money is a good that can only be produced by banking institutions”

    No, the central bank can create base money also.

    “its price – the interest rate – changes”

    No, interest rates are the price of credit, not the price of money. Those are different things. (The price of money is the inverse of the price level, 1/NGDP.)

    “The CB has to lower interest rates in order to increase the demand for money, otherwise it cannot engage in an OMO.”

    You have this completely backwards. It is OMOs that cause interest rates to lower. The central bank has no direct power to “lower interest rates” (aside from setting expectations), ahead of doing OMOs. The OMOs come FIRST; the interest rate changes are a RESPONSE.

    Secondly, we weren’t talking about increasing the demand for money. The whole point of the Hot Potato Effect is that the central bank can force the public to hold additional cash (by engaging in OMOs), which is GREATER than the public’s current money demand. It is in fact this imbalance which causes the effects of monetary policy (as the public attempts to “get rid of” the excess cash the central bank has forced it to hold, but in vain).

  22. Gravatar of Paul Paul
    15. July 2019 at 14:44

    Don, Scott has argued before that lower interest rates increase the demand for money, so OMOs cannot just change the stock of money and the interest rate independently of the demand. You are completely wrong about OMOs. The CB does set the FFR by fiat; it just supplies whatever reserves are demanded at that rate on an overnight basis, sometimes increasing the stock of reserves by orders of magnitude during the daylight hours to meet demand. There is no functional constraint on spending from reserves, and new bank reserves don’t cause any additional spending to occur.

  23. Gravatar of Don Geddis Don Geddis
    15. July 2019 at 15:35

    @Paul: “OMOs cannot just change the stock of money and the interest rate independently of the demand”

    I never claimed that. Everything of course affects everything. But the change in demand due to interest rate changes is a downstream side effect. This is very very different from your claim, which was “The CB has to lower interest rates in order to increase the demand for money, otherwise it cannot engage in an OMO.” That claim of yours is false. The CB can easily engage in OMOs immediately, without changing demand. Whether that action might LATER result in some demand change is not an important question.

    “The CB does set the FFR by fiat”

    That is false. The CB has no direct control over the https://en.wikipedia.org/wiki/Federal_funds_rate which instead is the rate that commercial banks charge EACH OTHER, and is “negotiated between the two banks”. The central bank is NOT INVOLVED in FFR transactions.

    “new bank reserves don’t cause any additional spending to occur”

    This is more complicated to analyze (although the fundamentals haven’t changed) since 2008, when the Fed began paying IOR. But for the century prior to that, excess bank reserves were essentially zero. So new excess reserves immediately resulted in additional spending, as banks reduced their excess reserves back to zero. (And then the spending continues to increase, as the excess cash causes a HPE throughout the public.)

  24. Gravatar of Paul Paul
    15. July 2019 at 17:14

    Don, either the demand for money must increase (due to, say, a liquidity crisis) or the CB must lower the policy rate in order to increase the stock of base money. They could, in some bizarre world, using the quantity of money as their target (as the old monetarists wanted), but we have no evidence they’d be able to hit their targets consistently or at all. Money-aggregate targeting was abandoned by CBs almost as quickly as it was picked up.

    Sorry, but pre- or post-2008, you are right that the fundamentals are not any different: banks don’t need reserves to lend, CBs need to create reserves to support lending. Increasing the ability of banks to settle interbank payments through the federal funds market doesn’t create profitable borrowers or investment opportunities for companies. This has led some who had attached themselves to monetarist or neo-monetarist beliefs to fault to boogeyman of IOR, but I am not the only one who thinks it’s implausible that 0.25% IOR prohibited a 4-fold increase in the base from causing additional demand, in a world where the base has any relationship to aggregate demand (I don’t think it does, which explains the problem).

  25. Gravatar of Don Geddis Don Geddis
    15. July 2019 at 18:45

    @Paul: “either the demand for money must increase (due to, say, a liquidity crisis) or the CB must lower the policy rate in order to increase the stock of base money.”

    What a bizarre, and easily falsifiable, claim. There are trillions of dollars worth of assets available in the secondary Treasury market, the MBS market, foreign exchange, and other assets available for Fed purchases. The Fed has the technical ability to create new money and purchase any of these assets. Overnight, it could trivially double the monetary base, without first taking any action at all to increase the demand for money, or to lower the policy rate.

    Of course, that massive increase in the monetary base will likely cause ripples throughout the economy, and when the economy eventually settles down into a new equilibrium, perhaps money demand will have increased, perhaps the policy rate will have decreased. Perhaps, or perhaps not. But it doesn’t matter!

    What matters is that the Fed has the ability to increase the stock of base money now, immediately, with no preconditions.

    “They could, in some bizarre world, using the quantity of money as their target”

    Yes, exactly. If the Fed wants to double the monetary base, then it can. By fiat, by choice.

    “we have no evidence they’d be able to hit their targets consistently”

    We haven’t yet talked about any targets. That is an entirely different conversation. For sure, the Fed cannot both double the monetary base, AND ALSO hit a 2% inflation target. But nobody ever claimed that. Were you somehow assuming a 2% inflation target in all this? You should have made that clear, when you falsely claimed that the Fed “cannot just change the stock of money”. Apparently, you neglected to include the crucial caveat “and also hit a 2% inflation target”.

    “Money-aggregate targeting was abandoned by CBs almost as quickly as it was picked up.”

    Nobody is advocating Friedman’s k-percent rule.

    Once we are clear about what the Fed can accomplish technically, we can have a separate discussion about what target the Fed SHOULD aim for. Sumner strongly advocates for a NGDPLT target, probably 4.5% annually or so. But that’s a completely orthogonal discussion.

    “I am not the only one who thinks it’s implausible that 0.25% IOR prohibited a 4-fold increase in the base from causing additional demand”

    I would be delighted to hear your explanation of a century of zero excess reserves, suddenly changing in 2008 to trillions of dollars. Please explain this graph: http://cfa-wpengine.netdna-ssl.com/marketintegrity/files/2014/02/Reserve-Balances-with-Federal-Reserve-Banks.jpg

  26. Gravatar of Paul Paul
    16. July 2019 at 05:33

    “There are trillions of dollars worth of assets available in the secondary Treasury market, the MBS market, foreign exchange, and other assets available for Fed purchases. The Fed has the technical ability to create new money and purchase any of these assets. Overnight, it could trivially double the monetary base, without first taking any action at all to increase the demand for money, or to lower the policy rate.”

    Why would anyone sell these highly safe, liquid, interest-earning assets to the Fed in exchange for base money that earns, at most, 0.25%?

    The implication in monetarism and market monetarism is that the Fed can FORCE people into primary deals, without changing market incentives or relative prices at all.

    I also meant the Fed can’t “just increase the stock of money” unless they want to abandon the interest-rate targeting regime they’ve used for decades. The Fed can only “force” more reserves on banks at a given policy rate if they pay IOR.

    “Nobody is advocating Friedman’s k-percent rule.”

    But you are advocating the quantity theory of money, which posits that the money stock has an independent, causal relationship with prices and output, instead of just being determined by the dynamic processes at work.

    “I would be delighted to hear your explanation of a century of zero excess reserves, suddenly changing in 2008 to trillions of dollars.”

    Easy. Reserves have never caused any additional spending, the Fed just decreases and increases the stock of reserves as necessary. The misguided QE procedures did nothing because they never could do anything. Giving banks reserves doesn’t make them want to lend or acquire assets.

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