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Friday, July 12, 2013

'Show Me the Model'

Antonio Fatas:

Show me the model: Most of the commentary one reads these days about the negative consequences of the policies set by central banks (low-interest rate and quantitative easing) are not backed by any economic model that I know. The criticisms make constant reference to "distorted" interest rates, "artificially low" cost of capital, mispricing of bonds and other assets as channels through which the misguided policies of central banks are causing low growth, uncertainty and volatility. But what is the economic model that can provide a theoretical justification...? ...
When we teach the effects of monetary policy we tend to use economic models that have a Keynesian flavor..., with some form of price rigidity and where changes in the nominal interest rate by central banks have a short-run impact on real interest rates (as inflation moves slowly). But this only works in the short run, while prices are rigid. Once price flexibility kicks in there is no way for the central bank to have an influence on relative prices (of assets or goods and services). 
But what I find most puzzling is that those who talk about distorted and manipulated interest rates are the ones who tend to criticize the predictions of Keynesian models in the first place! They are the ones who tend to use as a justification for their arguments models where central banks have no impact on the economy even in the short run. How is it that now suddenly central banks have become so powerful that they can determine "real" (relative) prices for an extended period of time? I need to see the model.

See here too: The Monetary Debate: Enter Chewbacca.

    Posted by on Friday, July 12, 2013 at 12:16 PM in Economics, Monetary Policy | Permalink  Comments (53)


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