Monetary Policy is powerful, for good or ill

Scott Sumner links to this post by Matt Iglesias:

To step back to the hyperinflation. You might ask yourself how things could possibly have gotten that bad. And the answer really just comes down to refusal to admit that a mistake had been made. To halt the inflation, the Reichsbank would have to stop printing money. But once the inflation had gotten too high for Reichsbank President Rudolf Havenstein to stop printing money and stop the inflation would be an implicit admission that the whole thing had been his fault in the first place and he should have done it earlier. It was easier to say that hyperinflation was a necessary consequence of allied demands for reparations payments and that he had no choice but to print currency in the quantity demanded.

So I decided to describe the process in charts. The set of charts below illustrate the path of the (log) price level in Brazil. Before inflation was finally tamed in mid 1994, several “stabilization plans” usually based on price freezes were enacted. Notice that the effect of the “policy” was longest after the first plan in 1983, becoming progressively shorter. That satisfies the definition of “crazy”: Someone who does the same thing over and over and each time expects a different result. In the Collor Plan they “innovated” and confiscated 80% of everyone´s liquid assets! The result was a kink in the slope of prices, meaning the rate of inflation decreased somewhat. But in 1994 when the Central Bank decided enough was enough, inflation immediately “disappeared” as if by “magic”.

The chart below graphs the rate of monthly inflation over the same period.

The charts below illustrate the same pattern for famous hyperinflation episodes (some of those are discussed by Thomas Sargent in “The End of four big inflations”). The pattern is clear: When the monetary authority sets its mind to do it, inflation stops immediately.

Scott Sumner discusses the 1937 “cover-up” episode:

This reminded me 1936-37, when the Fed made the mistake of doubling reserve requirements.  Late in the year the economy slumped badly, and it was clear that the decision had been a mistake.  At the November FOMC meeting they discussed the possibility of reversing the decision:

… If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)”

The chart below shows that: 1) The change in MP quickly reversed the deflation that went on from 1929 to early 1933 and, 2) The reversal in MP quickly brought deflation back in mid 1937!

So Iglesias conclusion is consistent with the data. If the Central Bank makes a mistake it will keep making it, unless you change the “actors” in the process. They are terrified of being “blamed”.


8 thoughts on “Monetary Policy is powerful, for good or ill

  1. Pingback: Monetary policy can’t fix all problems « The Market Monetarist

  2. That satisfies the definition of “crazy”: Someone who does the same thing over and over and each time expects a different result.

    This reminds me of Michele Weiner-Davis’s book Divorce-Busting. In the first few pages, as I recall, Weiner-Davis says that most people think that if what they’re doing isn’t working, they should do more of it, and louder.

    • One of the most amazing stories anyone ever told me:

      A physician-researcher I knew, who now heads a medical school, told me that he and many of today’s leading medical researchers were trained by a revered med school professor at Columbia.

      The main lesson this professor taught all of his students, the lesson he repeated over and over again, the lesson he drilled into the minds of some of the most brilliant students in the country:

      If what you’re doing isn’t working, try something else.

  3. Pingback: ラルス・クリステンセン 「金融政策はあらゆる問題を解決するハンマーではない」 — 経済学101

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