Don’t ease monetary policy; cut rates instead

11th June 2019 Off By binary
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David Beckworth directed me to a new piece by Jeffrey Frankel:

A Trade War is No Reason to Ease Monetary Policy

A trade war is a negative supply shock, and central banks cannot counteract the negative effects of current policies on real incomes in the United States, the United Kingdom, and many other countries. Only voters can do that

He’s right.  A supply shock does not provide a reason to ease monetary policy, as it’s an adverse supply shock.  The Fed should not boost AD to offset a supply shock.  Rather, it should prevent AD growth from changing by keeping interest rates at the Wicksellian equilibrium rate.  Because a trade war will generally reduce the equilibrium interest rate, the Fed should cut rates to avoid changing monetary policy.

PS.  Some (most?) economists believe that cutting interest rates is equivalent to easing monetary policy.  I find that horrifying.

PPS.  I was not able to read the entire Frankel piece, as it’s limited to subscribers.  But the opening bit is 100% correct.




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