Way back in my first year of Grad School, I enrolled in ECO 401: Studies in Monetary Theory. To my amusement and surprise, the entire semester was spent deriving the Basic Neo-Classical Model and its extensions within the ‘Real Business Cycle Theory’ framework. RBC was the most promising development in macroeconomics for decades. The amusing thing about RBC is that money does not play a part anywhere in the model – our studies in Monetary Theory class had no money in it at all!
The RBC movement somehow lost its momentum, in my view because (i) its damn hard to work with and (ii) it was a serious threat to the trendy new-Keynesian ‘we can deliver utopia’ grip on government policy formulation. Nontheless, it remains a prophetic contribution crying for a renaissance in these dark days of QE, Negative Interest Rates, Helicopter Money and other policy ideas which qualify as Monetary Stupidity. As its name suggests, RBC models argue that ‘real’ variables are driving cyclical variation in the macro-economy, as opposed to purely nominal variables. Money is ‘super-neutral’ and therefore monetary policy has no influence on real activity – sound familiar?
Lets examine the three hot topics in monetary stupidity…
1. Quantitative easing. The idea is for the Central Bank to buy all sorts of long dated bonds, by expanding the monetary base, to reduce long dated interest rates to ‘stimulate’ investment. The result was (i) long interest rates did not fall (ii) the velocity of money collapsed which means that all the monetary expansion flowed back as deposits with the Central Bank. Failure.
2. Negative interest rates. The idea is for the Central Bank to charge banks for holding deposits in their reserve accounts. This should convince them to lend. The result is (i) nominal interest rates go negative for the banks but (ii) nominal interest rates do not fall below zero for you or me so the private sector does not expand its investment orconsumption or anything. The astounding feat of this policy is that nominal interest rates actually go negative for a subset of the financial markets (violating an arbitrage bound), but there are no real effects. Failure.
3. Helicopter drops of money. The idea here is that the Central Bank bypasses the banking sector and gives you and me some money to spend. Depending on your economic beliefs this should either lead to a one-off jump in prices or a utopian stimulus to output and employment. While this idea gets ridiculed in the press, it is actually the closest thing to the classical monetary experiment that we can think of, so why hasn’t it been tried before? Well, it has, famously causing the German hyperinflation during the Depression and most recently in Zimbabwe (same outcome). My prediction: Failure to stimulate anything real and lasting.
So, three dumb ideas, three failures yet our Monetary Policy leaders keep trying despite what the Real Business Cycle theorists proved all those years ago…MONETARY POLICY DOESN’T MATTER!