Big Questions for Monetary Policy, New Ways Gauge the Decline, and the Fed Lends Dollars Around the


  • Three Big Questions For Monetary Policy
  • Indicators For Changing Times
  • A Dollar Short

The U.S. Federal Reserve’s aggressive moves to support financial markets attracted a mix of wonderment, endorsement and admonishment. Its actions breached past boundaries, and reached far beyond the banking sector. The Fed was accused of creating moral hazard and favoring investors at the expense of ordinary citizens.

The year was 2008, and my family and friends were vigorously debating these topics at our Thanksgiving table. I was home for a brief visit during a three-month assignment at the Federal Reserve Bank of New York. All I wanted to do was indulge in family, food and fellowship; but my guests were obsessed with bailouts, bond purchases and bank failures.

In the present day, the Fed has been even more aggressive, giving new life to the concerns that were raised during the global financial crisis. And because elements of the Fed’s playbook have been adopted around the globe, those concerns are again being debated in a number of world capitals. In this essay, we will attempt to provide some answers to the central questions surrounding crisis-era monetary policy.

1. Will All of This Easy Money Lead to Runaway Inflation?

Over the past two months, many central banks have stepped up their purchases of government securities, while others are doing so for the first time. Mechanically, the central bank creates money to purchase the securities. Governments use the proceeds of the borrowing to stimulate the economy. In essence, the printing press has been revved up in an effort to support demand.

Weekly Economic Commentary - 05/08/2020 - Chart 1

Using data through the late 1970s, Milton Friedman asserted that inflation is everywhere and always a monetary phenomenon. Recent increases in money supply growth have consequently made some observers uneasy.

But the link between money and inflation had been fraying over the course of the last thirty years, due to globalization and technology. Central banks long ago abandoned money supply targeting in favor of inflation and interest rate targeting. Further, the expansion that just ended was characterized by persistent downward pressure on the price level, despite low levels of unemployment and money supply growth averaging nearly 6% per year. Our thoughts on why inflation has been so low can be found here.

“Deflation, not inflation, is the bigger risk at the moment.”

The expansion of central bank activity has yet to register meaningfully in inflation expectations, which remain very low in most countries. The recent collapse in global demand probably makes deflation more of a near term risk than inflation, an outcome that frightens central bankers because it is difficult to dislodge.

The day may come when inflation moves ahead more rapidly than we would prefer. But that day does not look imminent. And when it arrives, central banks have the means to restrain the price level by raising interest rates.