“If the Fed is God, …”

Many (most… all…) claims about money policy contain some predicate, explicit or not, that the money authority actually can have real effects (e.g. Hamilton, “If you think that the Federal Reserve is responsible for more than 15-20% of the variation in the CPI, …”). This seems to be a pretty important assumption. Why don’t I know if its been tested or not?

I guess one way its tested is to produce models that don’t have money policy but explain big chunks of the data. Is this what RBC was all about? Does a current strand of the literature continue this line of research?

The Great Depression was a test of this assumption, but I want more than narrative evidence (i.e. more than one data point).

2 thoughts on ““If the Fed is God, …””

  1. All models with real rigidities apply (e.g. Farmer’s hybrid RBC-Search model, just to pick *something*).

    Also, RBC is so alive. Investment shock and time-varying depreciation are interesting and helpful.

    But this is not the best idea, imho… you need to be very… econometrical about this. I think one can entangle the money-income causality (if any), at a quantitative level, by looking at natural experiments, i.e. tightening and expansions that do not come as a response to GDP or unemployment conditions. — I can’t think of any examples. Barro-Gordon makes things harder, if I think about it.

    Lucas said we should let him engineer a recession and I think it might just be worth it to let him. 😉

    Finally, even if money moves income in the short run (up to 2 years?) then it moves it slowly/little. This is what current vintage “New Keynesian” macro models say, compared to say, ye’ olde multiplier-accelerator models *gasp*.

    There’s also that one paper, can’t look up now, which basically says that you need to control for the usual changes in banks’ demand for reserves. If you take those out of your favorite M aggregate then the rest is more powerful in explaining output and unemployment changes. (I.e. banks wanting to unload reserves during normal operations vs. the Fed wanting to cut reserves/the base.)

    Also, while on/near the subject, I really don’t understand people who don’t believe menu costs models as structural but who want to sell them as sort-of-reduced form, i.e. the menu cost proxies for other, more interesting costs, calibrate a parameter and go.

    Flaubert, Cicero, Zeus! Somebody save me from this hellhole that is macro policy! (GTA3 reference for the connoisseurs).

  2. What’s your priors on how important, relative to real shocks, money shocks are? What would be the effect of blowing up the Fed?

    I think I need to think about this some more. In the original post, I didn’t mean to ask “how many moments of the data can you explain without money”. I don’t care, so much, about money shocks.

    Instead, I meant something like “what mechanisms do we imagine gives power to monetary policy”. I guess I’m looking for something like the micro/macro back and forth regarding pricing in the micro data versus modelling assumptions (you know state dependent versus calvo pricing, etc).

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