Academic journal article NBER Reporter

Monetary Economics. (Program Report)

Academic journal article NBER Reporter

Monetary Economics. (Program Report)

Article excerpt

Understanding what monetary policy can do to enhance economic performance (and, just as importantly, what it cannot do) is a continuing challenge for economic policymakers around the world. Researchers in the NBER's Monetary Economics Program contribute to this effort with a combination of theoretical and empirical studies on the effects of central bank actions and the design of monetary policy. These studies are circulated as NBER Working Papers, presented and discussed at regular Program meetings, and subsequently published in NBER volumes and academic journals.

Our regular program meetings also aim to facilitate interaction between researchers working in universities and those working in central banks. Much frontier research on monetary economics occurs within research staffs of the Federal Reserve System and other central banks around the world. These central bank researchers often are invited to present their work and to participate in the discussion of other recent studies. We are delighted that Ben S. Bernanke, one of our long-term members and program director for the past two years, was appointed by President George W. Bush in 2002 to become a Governor of the Federal Reserve. When he was confirmed, I returned to the role of Program Director, which I had held previously.

In this report, I summarize a few of the strands of research on monetary economics that have engaged NBER researchers in recent years. None of these issues is fully settled, but significant progress has been made. In the process, I will offer a few of my own judgments about what we know and about where more research is still needed.

The Dynamic Effects of Monetary Policy

According to textbook theory, changes in monetary policy influence employment and production in the short run but, in the long run, affect only prices and inflation rates. When a central bank slows the rate of money growth, for instance, the end result will be a lower rate of inflation, but the transition to lower inflation can take some time, and it often entails a period of depressed economic activity, including higher unemployment. This short-run tradeoff between inflation and unemployment is often called the Phillips curve, after the classic study of this topic by A. W Phillips in the 1950s. Much research in the NBER Monetary Economics Program has been devoted to documenting and explaining these dynamic responses to monetary policy.

One approach to this empirical issue is to study particular episodes of disinflationary policy. A classic study following this approach is that by Christina Romer and David Romer. [2966] Following in the footsteps of NBER researchers Milton Friedman and Anna Schwartz and their renowned Monetary History of the United States, the Romers read through the minutes of the meetings of the Federal Open Market Committee to identify episodes in which Fed policy switched toward a tougher stance against inflation. They find that after each of these so-called Romer dates, the economy experienced a substantial decline in production and employment. The Romers interpret their findings as strong evidence for the effect of monetary policy on real economic activity.

In another study, Laurence M. Bali looked at data from OECD countries and found every episode in recent history during which the inflation rate experienced a significant and sustained decline. [4306] In almost every episode that Bali identified, the country also experienced a period with output below trend. This is consistent with a short-run tradeoff between inflation and real economic activity. Ball reports that the output effects are smaller (that is, reducing inflation is less costly) when the disinflation is rapid and when a country has more flexible labor contracts.

More recent studies on the dynamic effects of monetary policy have taken a very different approach to the data, but they have reached broadly similar conclusions. A common methodology is to try to identify "monetary policy shocks" -- movements in some measure of monetary policy that cannot be predicted or explained contemporaneously with the economic variables that typically drive monetary policy. …

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