The Debate on Monetary Policy: Can and Should a Central Bank Do Structural Policy?

The Debate on Monetary Policy: Can and Should a Central Bank Do Structural Policy?

“NO!” says the international consensus, and almost all reputable central banks have followed. Central banks seemed to have accepted, adopted, and even executed a monetarist paradigm which claimed that monetary policy, although effective in the short-run, is at best neutral in the long-run. Most central banks therefore tried to avoid any involvement into long-term, structural issues, became independent from government, and even tried to enhance their “neutrality” by adopting monetary policy rules.

However, at least two central banks stick out as major exceptions: the Federal Reserve of the U.S. and the Bank of Japan. Both institutions are confronted with economic conditions they consider as “structural” changes, and they react by overruling the conventional central banking wisdom, which calls for a mere stabilization of a given development path of the economy. In the U.S., the Fed accommodates growth rates of a boom which would have been coined a “bubble” under (historically) normal conditions. Instead of fighting against booming demand and skyrocketing stock prices, which rang the alarm bells in its models, the Fed opted to accept, or even cherish a “New Economy” with unexpected growth rates. In Japan on the other hand, a financial crisis, which spread (or rooted?) in the very foundations of the economy became the base “structural” argument for the Bank of Japan to keep its policy tight. It argues, that even though standard indicators (stagnating GDP, falling prices, and exchange rate appreciation) might recommend further monetary easing, the structural problems of the economy demand a restrictive stance which should not dilute the current restructuring efforts of finance and industry too early.

In the lecture, we will reconsider the arguments for monetary neutrality, will have a closer look at the policy of both central banks during boom and bust, and will discuss if our “conventional wisdom” of monetary neutrality is challenged.