Monday, January 6, 2014

Market Monetarism vs. new Keynesian

Scott Sumner asked how Market Monetarism is different from the new Keynesian economics.

There is a lot of difference between Market Monetarism and the new Keynesian mainstream of a backward-looking Taylor rule.

Those new Keynesians who favor adjusting policy interest rates to target the forecast for the growth path of nominal GDP as a policy regime are not the mainstream.     But certainly they still count as new Keynesians.

So what is left?

Market Monetarists favor allowing market forces to determine all interest rates at all times.  

We do not favor having the central bank "set" any interest rate or especially to make commitments as to what those interest rates will be in the future.

For example, Market Monetarists do not favor keeping the Federal Funds rate near zero for an extended period of time, one or two years, or even until unemployment falls below 6.5% or inflation rises above 2.5% in the medium run.  

Market Monetarists especially don't favor quantitative easing as a means to lower long term interest rates.

The theoretical framework of Market Monetarism is that spending on output depends on the quantity of money and the demand to hold it.   And the quantity of money should be adjusted according to the demand to hold money given a level target for nominal GDP.

Sumner did discuss the new Keynesian focus on interest rates, but  is it really true that new Keynesians focus on the difference between a policy rate and the Wicksellian natural rate?

As for the difference Sumner emphasizes, the use of "the market" as an indicator of monetary policy, I think that is less essential.    I have a longstanding interest in index futures convertibility, but I have never believed that it is practical to use stock prices or commodity prices to judge the proper level of base money.  


  1. "We do not favor having the central bank "set" any interest rate or especially to make commitments as to what those interest rates will be in the future."

    The way I see it, it's impossible for a central bank as issuer of reserves not to set a few interest rates. For instance, if it chooses not to pay interest on reserves, it has set IOR = 0. Or it can choose to set IOR > 0. Either way, it's gotta set a rate.

    There's also the rental rate on reserves, the fed funds rate. If the Fed chooses not to set the fed funds rate at some fixed amount for a period of time, then it'll flap around like crazy.

    1. I favor having the interest rate on reserves float. For example, 50 basis points below the 3 month T-bill rate.

      While I agree that a central bank can stabilize short term interest rates, including the Federal Funds rate, I don't agree that it must "flap around like crazy" without such efforts. There have actually been economies without central banks.

      What happens is that without a central bank stabilizing short term interest rates, banks hold more reserves and release or accumulate them according to changes in short term interest rates. The change depends on the interest elasticity of the demand for reserves.

      Of course, if the interest rate on reserve floats, this doesn't work.

      Anyway, if there is a central bank, I favor having it adjust the quantity of reserves according to changes in the demand to hold reserves. If done perfectly, there would be no fluctuation of short term interest rates due to changes in the demand to hold them. On the other hand, interest rates could fluctuate with changes in the demand for credit. How much fluctuation that would require depends on the interest elasticity of expenditure.

      Of course, perfection is not an option, but a central bank should make no commitments about interest rates.

      I don't think there should be any commitment about base money either.

      The central bank should adjust base money to the demand to hold it and allow interest rates to adjust to keep saving and investment equal--spending on output equal to potential.

      The only nominal anchor should be keeping expected nominal GDP on target.