Who took the money out of monetary policy?

In a recent economic discussion paper, Will Monetary Policy Become More of a Science?, Federal Reserve Governor Frederic Mishkin reviewed the progress economists have made in monetary theory and policy in recent decades. He had some good news for central bankers:

Monetary policy will however never become as boring as dentistry. Monetary policy will always have elements of art as well as science. (That is good news because it will keep life interesting for monetary economists like me.)

Not so boring - but there's a caveat:

However, the advances in the science of monetary policy that I have described here suggest that monetary policy will become more of a science over time. Furthermore, even though art will always be a key element in the conduct of monetary policy, the more it is informed by good science, the more successful monetary policy will be.

Mishkin's paper is worth reading for anyone interested in monetary policy (see also the comments at Mark Thoma's post). The paper was given in Frankfurt on 21 September at a conference to mark the 50th anniversary of the Deutsche Bundesbank: Monetary policy over fifty years (PDF). One of the other speaks was David Laidler, professor Emeretus at the University of Western Ontario, who spoke on: Successes and Failures of Monetary Policy since the 1950s (PDF). While quite upbeat, he is not uncritical:

Successes and failures in monetary policy stem mainly from coherence or lack thereof in the monetary order, rather than the tactical skills of policy makers. Crucial here are questions of consistency among the economic ideas that the policy regime embodies, the way in which the economy actually functions, and the beliefs of private agents and policy makers about these matters.

These postulates are used to frame accounts of the Bretton Woods System and its collapse, the Great Inflation that followed, the subsequent disappointing performance of moneygrowth targeting, the breakdown of the Japanese "bubble economy" the onset of theEMS crisis at the beginning of the 1990s, and since then, the launch of the Euro and the apparent success of inflation targeting. Though monetary policy seems rather successful at present, certain weaknesses in currently prevailing monetary orders are noted.

The implications are interesting. Like fund managers, for central banking it is more about the coherence of the framework and the process of the 'monetary policy regime' than it is the specific people. On this reading, Greenspan is either an outlier (like a star fund manager) - or has simply taken too much of the credit for the 'great moderation'.

And what about the weaknesses Laidler identifes? His main concern is the mistaken "view that the quantity of money is irrelevant for monetary policy":

Over-exclusive emphasis on the role of interest-rates in monetary policy has already done damage, having, in the 1990s, led the Bank of Japan into thinking that, once short interest rates reach zero, it had exhausted its options, and hence into not tackling promptly and vigorously the credit deadlock which followed the collapse of the “bubble economy”.

...the fact that demand for money functions proved insufficiently stable over monthly or even quarterly intervals to provide a basis for regular monetary policy decisions, does not imply that the only variables of any significance for monetary policy under any circumstances are the short interest rates that central banks use as their instruments, but it seems to be widely believed nowadays that this is the case.

Laidler sums up:

In short, though inflation in the world economy is now lower and more stable than anyone would have predicted even as recently as the beginning of the 1990s, and though we may be closer to a coherent international monetary order now than at any time since the late 1960s, the way forward is not yet risk-free.

Comments

[Marc Shivers]

Thanks much for the link to Laidler's paper. Most of Don Kohn's talk at the conference was keyed off of Laidler, but no reference was provided in the his speech...