Does tight monetary policy slow the economy more than easy monetary policy accelerates the economy? Recent U.S. experience suggests that may be the case. When monetary policy was tight in 1988 and 1989, the economy seemed to slow in response. Yet when monetary policy was eased in 1990, the economy did not respond accordingly.
The suggestion that monetary policy has such asymmetric effects is not altogether new or unorthodox. Indeed, mainstream economists adopted this view for several decades after the Great Depression, when easy monetary policy seemed powerless to revive the economy. Recent studies have revived interest in the asymmetric effects of monetary policy. Theoretical research has suggested reasons why tight policy may have more impact than easy policy. And empirical studies, which use monetary growth to identify the stance of policy, have produced evidence of asymmetry.
Of course, not all changes in monetary growth may reflect changes in policy. Recent growth in M2, for example, has been very slow even though monetary policy, judging from the statements of policymakers themselves, has been decidedly easy. Moreover, various measures of money can give contradictory indications of the stance of monetary policy. So studying only the monetary aggregates may lead to the wrong conclusions about the stance and the impact of policy.
This article looks for evidence that monetary policy has asymmetric effects using two alternative measures of the stance of policy: (1) the federal funds rate and (2) a narrative index based on the statements of policymakers. The article finds some evidence of asymmetry using both measures of policy. The first section of the article traces the history and possible causes of asymmetry. The second section presents some evidence that the impact of monetary policy is asymmetric.
ROOTS OF ASYMMETRY
The notion of asymmetry was born in the Great Depression. That event convinced many that easy policy was powerless against recessions, even if tight policy could check a boom. One reason heard then for asymmetry is still heard today: a loss of confidence by firms and consumers during recessions makes monetary policy less effective. Two other reasons given today are credit constraints that augment only tight policy, and prices that are less flexible downward than upward.
HISTORY OF ASYMMETRY
Economists have entertained the possibility of asymmetry off and on for decades. Until the end of the 1920s, most believed the impact of monetary policy was symmetric. It was thought that policymakers controlled a lever that could lower or raise the level of economic activity equally well. By raising interest rates, the Federal Reserve could slow the economy, and by lowering rates, the Fed could stimulate the economy. The apparent success of monetary policy in turning around mild recessions in 1924 and 1927 bolstered faith in the effectiveness of easy policy (Hansen).
This faith in easy policy was shaken by the Great Depression, which convinced many economists that only tight policy was effective. After the economy turned down in 1929, short-term nominal interest rates soon declined to less than 1 percent. The low level of interest rates convinced the Federal Reserve it was pursuing an easy monetary policy. Yet the Depression persisted until 1934, leading many to conclude that easy policy was futile, "like pushing on a string."(1)
According to monetary historians, the notion of asymmetry was widely adopted in the 1940s and 1950s (Mayer, Johnson). This view was also held by some within the Federal Reserve. A vice president of the Federal Reserve Bank of New York, for example, began an article in 1951, stating, "Two decades ago it still bordered on heresy to suggest that central bank control over interest rates was useless....Today that heresy has become widely accepted as dogma" (Roosa, p. 1).
Belief in asymmetry diminished in the 1960s and 1970s, after Friedman and Schwartz reexamined the monetary history of the Great Depression. …