Simon says: monetary policy is better, when possible

Simon Wren-Lewis writes:

There are practical reasons for preferring interest rate changes (when possible) to changes in government spending as the stabilisation tool of choice, although the extent to which these are inevitable or just conditional on current institutional arrangements is an interesting question. Here I want to give an economic reason for this preference.

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The government could prevent waste in two ways. It could persuade consumers to hold less money and buy more goods, which we can call monetary policy. Or it could buy up all the surplus production and produce more public goods, which we could call fiscal policy. Both solutions eliminate waste, but monetary policy is preferable to fiscal policy because the public/private good mix remains optimal.

Three comments on this reason for preferring monetary policy. First, if for some reason monetary policy cannot do this job, clearly using fiscal policy is better than doing nothing. It is better to produce something useful with goods rather than letting them rot…

He would have naturally come to the “solution” if he freed himself from the “monetary policy=interest rate policy” constraint and thought of monetary policy as providing a stable nominal background with, for example, a nominal spending (NGDP) target.

4 thoughts on “Simon says: monetary policy is better, when possible

  1. I’m just worried about the distributional consequences of monetary-first or monetary-only policies. In many situations, fiscal programs can get money into the hands of those with a high propensity to consume much much faster than monetary policy.

    • ng, you have it exactly backwards. If the Fed simply announced it was going to create money out of thin air and credit it to banks with accounts at the Fed, and then announce a policy of charging banks 2% to store that money as excess reserves at the Fed, the money would get into circulation, pronto.

      Or, they could simply send out checks to a randomly selected 20…50…100 million Americans. Either would be much faster than congress passing spending bills, the President signing, and the federal bureaucracy disbursing it.

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