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Monetary Policy: Targets and Rules

Monetary Policy: Targets and Rules. Price target Wicksell : adjust bank rate to “natural” rate of interest steady P Fisher: Reflate ! Counter debt deflation Inflation target : Woodford…Bernanke…et.al. Taylor rule Money growth target : Milton Friedman and the Monetarists

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Monetary Policy: Targets and Rules

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  1. Monetary Policy: Targets and Rules Price target Wicksell: adjust bank rate to “natural” rate of interest steady P Fisher: Reflate! Counter debt deflation Inflation target: Woodford…Bernanke…et.al. Taylor rule Money growth target: Milton Friedman and the Monetarists Nominal income target: n* = PY … P = n*/Y when Y deviates Koenig: offset real shocks as well as price shocks Optimally distributes risks between debtors and creditors Applied to Great Depression (citing Fisher, 1933 & Bernanke, 1994) Would have avoided “Mistake of 1937”

  2. Finance vs. Industry Conflict Finance – Industry Bankers – Industrialists Creditors – Lenders Tilt Toward Hard Money – Easy Money • Financial centers champion price stability Key currency  Global Reach • British return to gold at pre-war parity, 1925 • Fed defense of gold, 1931

  3. Epstein and Ferguson: Monetary Policy, Loan Liquidation and Industrial Conflict • Explaining Fed behavior in critical year: 1932 Inaction – Open Market Operations - Reversal • Friedman and Schwartz • Real bills doctrine: plenty of money for needs of trade • Congressional pressure, then recess • Epstein and Ferguson • Bank profits … regulatory capture • International constraints … villain gold • Pressures from industry • Liquidationist mindset … reduce wages!

  4. Andrew Mellon Secretary of the Treasury, 1921 – 1932 “…liquidate labor, liquidate stocks, liquidate the farmer, liquidate real estate. It will purge the rottenness out of the system…People will work harder, lead a more moral life.”

  5. Epstein & Ferguson: Explaining Inaction • Liquidationist mindset • Purge the system! • Curb government! • Reduce wages! • Gold standard constraints • Open market operations reduce gold cover of currency

  6. Epstein & Ferguson: Explaining Open Market Ops • Defense of gold  bank failures • BUY BONDS! … Prop up PB! … buoy bank solvency! • Political pressure: Congress … Irving Fisher • Glass-Steagle Act of 1932: T-bonds can back currency Epstein & Ferguson: Explaining Reversal • Loan liquidation by banks • Banks reduced loans/stocked up on short-term Treasuries Low interest rates  Low bank profits Banks couldn’t reduce deposit rates, fearing withdrawals • Uneven distribution of gold reserves between district banks • Gold drain by France, then Britain pressure on some districts • Chicago Fed pushed for reversal: • Chicago banks held lotsa T-bills…Chicago Fed short of gold

  7. 1932 Monetary Policy Dilemma • Reduce interest rate • Foreign withdrawals • Banks sell bonds to meet demands • Bond fire sale … PB down • Bank portfolio losses • Bank runs • Raise interest rate • PB down • Bank portfolio losses • Bank runs Fed tilted toward tightness  Set stage for final banking crisis • Alternative explanation of final banking crisis (early 1933): Fear of FDR: Devaluation? Unbalanced budget?

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