central banks

Rewriting the Monetary Policy Script

  • Why it matters

    Why it matters

    It is unclear whether generous monetary policies are stimulating economies or whether households continue to save rather than spend and policymakers are failing to question whether their assumptions work.

  • Facts


    • The European Central Bank is pursuing a generous monetary policy to stimulate growth in the euro zone but this is unpopular in Germany as people see their savings eroded.
    • The author argues that applying monetary policy too rigidly fails to account for unstable political environments, geopolitical tremors, or rising risks on financial markets that can set models off course.
    • Amid increasing inflation in Germany and Europe, pressure is growing on the ECB to abandon its quantitative easing program.
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Draghi und Yellen
Sticking to the rules isn't helping, some say. Source: DPA [M]

How long will major central banks blindly rely on rigid rules to control inflation and stimulate growth? Given the clear benefits of nimble monetary policy, central bankers need to open their eyes to the possibilities that flexibility affords.

The rule of thumb for monetary policymakers has long been that if inflation is below official target ranges, short-term interest rates should be set at a level that spurs spending and investment. This approach has meant that once interest rates reach or approach zero, central banks have little choice but to activate large asset-purchase programs that are supposed to stimulate demand. When circumstances call for it, policymakers default to the predetermined scripts of neo-Keynesian economic models.

But in too many cases, those scripts have led us astray, because they assume that monetary policy has a measurable and foreseeable impact on demand and inflation. There is plenty of reason to question this assumption.

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