Tyler Cowen argues that monetary policy matters less with each passing day because

1. Resource misallocation and unemployment get “baked in” to some extent, due to hysteresis.  I also would argue that some of the long-term unemployed are revealed as having been “baked in in the first place,” once the boom demand for their labor ended and their marginal products were more closely scrutinized.

2. Many nominal values end up reset, more and more as time passes and as new projects replace the old.

3. As banking and finance heal, debt overhang is less of an AD problem.  The debt repayments get rechanneled into investment, rather than falling into a black hole.

4. The Fed, at least right now, is not able to make a credible commitment toward a significantly more expansionary policy for very long.  Putting aside the more general and quasi-metaphysical issues with precommitment, just look at the key players. . . .

5. The Fed already has failed to act, for whatever reasons.  That makes it all the harder to achieve the credible commitment now.  The market expectation has become “the Fed can/will only do so much.”  . . .

So first lets address these points


On (1). Hysteresis seems to be widely misunderstood. At the very least the extent of our lack of understanding is underappreciated. First, and importantly, hysteresis goes both ways. This was an important part of Larry Ball summary of the issue.

Second, while lots of people have latched on to this erosion of skills idea, it is the one that is least compelling to me. I tend to think insider-outsider dynamics are more important as well as underinvestment in physical and social capital. However, just as a slow economy will under accumulate capital and hot economy will over-accumulate it.

(2) This is certainly true and it in large part explains why the economy is growing at, at least trend right now and perhaps slightly above. However, that is still well shy of full employment.

(3) I’ll have more on this in the coming days but this is exactly backwards. For some reason folks think of monetary policy as stimulating consumption but it works mostly through stimulating investment. Which is what one would expect given that “rate of return” is typically the key decision investment choices.

This “black hole” argument was an explanation for why monetary policy was ineffective in the first years of the crisis and hence as it recedes monetary policy should if anything be more effective.

(4) That the players are changing is even more reason to put the fear of God or at least the blogosphere into the hearts of the newcomers.

(5) I think this is largely correct, but the danger now is not simply that the Fed won’t agree to looser policy but that some are advocating tighter policy.


In the larger context there are two issues. One is our estimate of the time path of monetary effectiveness. The other is the time path of our estimate of monetary effectiveness.

To put it another way, it is one thing to look back and say wow, it would have really been a good idea to pressure Ben Bernanke back in 2009. However, if in 2009 you thought Ben was a a fire-breathing Dove and then in 2011 you find out that he is actually kind of pushover, then you want to increase the pressure. Even though the marginal benefit of change is less now, our estimate of the marginal benefit of pressing for change is greater.