ROBERT C. HOLLAND
This essay is about the limitations of monetary policy. In choosing this topic, I recognize that, given the success of monetary policy in recent years, I may sound to you like the football coach who, after the team scores a big win, says, "The defense gave up 150 yards; we missed three big passes; we fumbled; two of our best players got hurt: we've got real shortcomings." But such cautionary notes are necessary.
Monetary policy is a powerful instrument that has come off a big win. Monetary policy scored at the end of the 1970s and in the 1980s. By taking the right steps, it stanched an inflation that looked unstanchable as the 1970s drew to a close. In the later 1980s, as people looked to macroeconomic policy to smooth out our economic ups and downs, the other major instrument of economic policy, fiscal policy, became so distended by a succession of deficits that it had virtually no flexibility left to inject some countercyclical impetus in economic policy.
Monetary policy became the only macro-instrument left in town with the leverage and ability to move and change. But monetary policy has not always been so dominant.
When you look back at our monetary history, you will see that, more often than not, our society was asking monetary policy, the central bank, to do things monetary policy could not do. Thus, a careful and realistic analysis of monetary policy and its structural limitations is necessary in order to decide what we should ask it to do and to prevent society from asking it to do more than it can.
There are three broad categories of limitations. The first is limitations in human capabilities--predilections, frailties. The second is structural limitations inherent in our central bank--how the Fed operates and what it operates on. The third is economic structural limitations--problems and shortfalls imposed by the basic economic structure.