Saturday, May 18, 2013

The Role of Monetary Policy, Revisited

I am giving a talk Thursday May 30, titled  "The Role of Monetary Policy, Revisited."  The event is at Booth's Gleacher Center in downtown Chicago, reception 4:30 and talk 5:15. It's part of a series of talks sponsored by the Becker-Friedman Institute.

The talk is based on  an essay I'm working on, and will be presenting at a few central banks this summer. Once per generation we re-think what central banks do, can't do, should do, and shouldn't do. Milton Friedman's famous 1968 address marked the last big transition. I think, we are in a similar moment. I will look at the big picture in the same spirit. I'm aiming at a serious talk, grounded in academic research, but accessible.

Blog followers, students, colleagues, friends, and even glider pilots are most welcome. Please rsvp so they know how many people to plan for.

The event announcement invitation and rsvp links are here on the BFI webpage

There is also an event announcement and rsvp link on the Booth Alumni events webpage here.

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Becker Friedman Institute
The Becker Friedman Institute for Research in Economics of the University of Chicago cordially invites you to
The Role of Monetary Policy Revisited
A talk by John H. Cochrane, AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Thursday, May 30, 2013
4:30 p.m. Reception
5:15 p.m. Talk and Q&A
Executive Dining Room, Sixth Floor
University of Chicago Gleacher Center
450 North Cityfront Plaza Drive
Chicago, Illinois (map and directions)
Please join us as University of Chicago Booth School of Business Professor John Cochrane reexamines Milton Friedman's 1968 presidential address to the American Economic Association. In this famous speech on the role of monetary policy, Friedman argued, "There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off."
Starting from this perspective, Cochrane will reevaluate the role of monetary policy 45 years later. Is it effective? Can it fill all the roles people expect of it? How should monetary policy be conducted going forward?
Please respond online by
May 23.
Please extend this invitation to others who might find the program of particular interest.
Complimentary valet parking will be available at the Gleacher Center entrance.
If you have questions or require advance assistance, please contact Maria Bardo-Colon at 773.834.1898 or
John H. Cochrane
The AQR Capital Management distinguished service professor of finance at the University of Chicago Booth School of Business, Cochrane's scholarly work focuses on finance, monetary economics, macroeconomics, health insurance, time-series econometrics, and other topics. He is the author of
Asset Pricing, a coauthor of The Squam Lake Report, a research associate of the National Bureau of Economic Research, a senior fellow of the Hoover Institution at Stanford University, and an adjunct scholar of the CATO Institute. He blogs as The Grumpy Economist. Cochrane earned a bachelor's degree in physics at Massachusetts Institute of Technology and PhD in economics at the University of California, Berkeley. He was a member of the University of Chicago Department of Economics before joining Chicago Booth.


  1. Wish I could see it. Your monetary policy views are nicely orthogonal to most out there (people who think it's all powerful on one hand and people who think monetary policy alone will cause rampant inflation on the other). Will you post the essay on the blog? Or better yet give the talk in New York?

    1. Expect decidedly out of the box and far from the minutiae of current policy debates. The BFI may tape it. It will also become an essay, which will get better over time and which I will post here in due time.

  2. I hope you will comment on Abeonomics in Japan. When I think of the grand debates (raging in my mind), one is Cochrane vs. Woodford. I think Japan is providing strong evidence that Woodford has been correct, where the two of you have disagreed. [].

    "Open Mouth Operations"

    The stock/bond/yen markets all were highly anticipatory of Abeonomics. Stocks rose and the yen weakened on Abe's statements and election chances, before he did anything. The market sure seemed to think the BOJ had a lot of power to hit a target and certainly seemed to think the BOJ could commit.

    "But it's a rare Phillips curve in which raising expected inflation is a good thing. It just gives you more inflation, with if anything less output and employment."

    Last quarter GDP showed nominal GDP up 1.5% and real GDP up 3.5%. I don't want to place too much emphasis on specific one quarter numbers, but the pattern of strong real GDP growth and price decreases, combined with strong expected inflation growth seems strong evidence for Woodford's view.

    I think you are both right that QE doesn't work through market segmentation type arguments. I think QE is just a strong signal of central bank commitment. When the BOJ announced massive money printing and purchases, the market is just learning how committed they are and on what time frame they intend to hit their 2% inflation target. That is, central bank policy works almost entirely through expectations and "open mouth operations." What is the largest point of difference between a Woodford/Svensson expectations centered view and a Cochrane/Taylor instrument centered view? Is it just their view that a central bank could or should commit to a level target and the instruments are secondary, where as Cochrane/Taylor view that as impossible or even dangerous?

    Anyway, certainly not trying to invent a straw man. Just stake out important differences between leading economists. I'd be curious how you read the events out of Japan.

  3. Central banks generally try to throw their weight against the effect of market forces - slowing the economy when it overheats and stimulating the economy when it cools down.

    I think an interesting rhetorical question is: There are legal and technical limits on what a central bank can do; are there also moral limits on how far a central bank should go in throwing its weight against to counter act the effects of policies enacted by elected governments even if the central bank strongly feels that the policies are wrong ("wrong" either in the sense that the policy goal is wrong or in the sense that the bank feels the policy will not achieve the desired goal).

    In England, the government apparently believes that austerity policies will lead to economic expansion. If the central bank felt that those austerity policies will lead to contraction, is it morally permissible for the Bank of England to undermine the democratic choice? Can it be argued that politicians and the public deserve to get the consequences of their democratic choices and deserve to get them good and hard.

    1. You guys are great. I didn't even put up a single sentence and you've got 4 great comments. "Monetary policy. Discuss amongst yourselves..." I can't wait until I actually put up a draft of the esssay! Or maybe I'll just staple together the comments

    2. A system where politicians have a say in stimulus (via fiscal policy) and well as central banks having a say (via monetary policy) is absurd. You might as well have a car with two steering wheels, each controlled by different people.

      A better division of labour is thus. There are POLITICAL decisions, e.g. what proportion of GDP is allocated to public spending and how that should be split as between education, law enforcement, etc etc. That should be strictly the preserve of the electorate and politicians.

      Second there is the question as to what stimulus is desirable. That is a technical question way beyond the competence of politicians. That decision should be taken by a committee of independent economists. And in fact stimulus is already decided largely by such committees: e.g. in the UK there is the Bank of England Monetary Policy Committee (which unlike its equivalent in the US has only one bankster on the committee). Plus there is the Office of Budgetary Responsibility.

    3. "That decision should be taken by a committee of independent economists."

      An "independent economist" is an oxymoron. Many economists would say that "stimulus" is ineffectual precisely because it is stimulus - here one day and gone the next.

      And some economists would say that the government's financing decision (fund with taxes, fund with debt, fund with equity) is as important as its spending decision, if not more so.

    4. That's a good question, but I think it misses an essential aspect of the role given the Federal Reserve and why that role was given.

      The Federal Reserve was designed so that it would be as independent from "politics" as feasibly possible. This was precisely so that it would not be subject to the vicissitudes of what is optimistically here called "democratic choices". The same might be said of the Supreme Court. Doesn't the Supreme Court often strike down laws of a democratically elected Congress and Executive that are (in the view of the Supreme Court) unconstitutional?

      The point here is that I think Congress and the Executive branch, in establishing the Federal Reserve *expected it* to run counter to certain policies enacted by Congress. Not only did they expect it to, they considered it part of the Federal Reserve's job. If it were otherwise, we really would not have a Federal Reserve in the first place. True, the FOMC and Federal Reserve members are not elected, but Congress and the Executive clearly delegated power to them precisely in order to protect the former from "politics" and indirectly "democratic choice" in its more literal and immediate sense.

      "Having two steering wheels each controlled by different people" as another commenter puts it, is really at the core of the design of American government---except that the original design was that there would be three, not two. And, that's a main aspect of its brilliance and the primary reason, I think, of its durability. And, despite what Ron Paul might think about the constitutionality of the Federal Reserve, the Supreme Court settled the issue in 1819 in McCullough v. Maryland and I don't expect the Court will change its mind any time soon.

    5. Vivian - I accept that central bank independence inherently implies that there are times when fiscal and monetary policy are going in opposite directions. Sometimes that is a good thing. A government that wants to balance its budget by cutting spending or raising taxes might be perfectly happy that a central bank responds by lowering interest rates reducing the negative impacts of the government policy. A government that was deliberately trying to provoke inflation might be less happy with a bank that raised interest rates to cool the economy.

      My question really is whether there are moral limits to how far a central bank could go to deliberately subvert a government policy it disagreed with. In the United States, Congress has decided that there will not be mortgage relief for borrowers and there will not be further stimulus programs. Indeed Congress has decided that there will be fiscal contraction. I have no problem with the Fed reacting to the consequences of those policies by keeping the short term interest rate very low. But I am troubled by the Fed doing an end run on political decisions (even though I might disagree with the political decision) by engaging in things like QE and the MBS buying program.

  4. "The talk is based on an essay I'm working on, and will be presenting at a few central banks this summer. Once per generation we re-think what central banks do, can't do, should do, and shouldn't do."

    Central banks (in their current incarnation) buy and sell government debt (usually short term) to set interest rates. Interest rates on government debt affect interest rates on all other forms of debt.


    1. Why can't this purpose be fulfilled by the issuing authority (Treasury department of the government)?
    2. Why must a government rely solely on debt to fund deficits?
    3. How do you reconcile a non-market process for government revenue collection (taxes), a non-market process for new debt issuance by a sovereign, and a market process for the setting of interest rates?

    "In this famous speech on the role of monetary policy, Friedman argued, There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off."

    Here Friedman is stipulating that there is no long run Phillips curve. I would argue that there need not even be a short run Phillips curve.

    1. Frank,

      I’ll have a go at answering your 3 questions.

      1. The problem with the Treasury “fulfilling this purpose” is that that gives politicians control of the printing press, which has obvious dangers. However, as I suggested above, the functions of central bank and treasury could perfectly well be merged, and as long as an independent committee of economists manage stimulus, that ought to work OK.

      2. Governments don’t need to “rely on debt to fund deficits”. Both Keynes and Milton Friedman said that governments can perfectly well print money rather than borrow it (that involves regarding government and central bank as a merged entity, which is a perfectly legitimate way to looking at them). In fact deficits over the last two years HAVE BEEN funded by money printing in that several central banks have simply printed money and bought up the bulk of debt created in that period.

      3. Nice question. The way I’d do the “reconciliation” is to abandon any attempt by government / central bank to influence interest rates, except in emergencies. I pointed out some of the defects in interest rate adjustment below. But for more details on this, see p.10 here:

    2. Ralph,

      On 1, the purpose that I was referring to is the setting of interest rates. In reality, before the central bank ever touches federal debt, it is first auctioned. The auction process usually involves some large bank / insurance group / pension / foreign country submitting bids to the U. S. Treasury to buy such and such duration with such and such rate of interest.

      Those bonds are then bought and sold after an auction rate of interest has been established on the bond to determine a market rate of interest. Why do you need a market rate of interest when the auction rate should suffice?

    3. As a follow up note. Some people might argue that Bernanke is justified in being aggressive with monetary policy because Congress is grid locked and someone has to break the grid lock. My answer would be that "grid lock" is a much a choice as any other and Bernanke should let Congress sort it out themselves rather than letting Congress dump the problem of their own making on unelected officials.

  5. I’ll be outside the meeting handing out leaflets with the following message.

    Monetary policy is bollix for the following reasons.

    1. There is no relationship between base rates and credit card rates. See:

    2. In a recession, certainly the initial stages of a recession, there is capital equipment lying idle, thus cutting interest rates with a view to encouraging investment is lunatic.

    3. The slump in private sector spending recently is primarily down to those underwater and relatively poor mortgagors. Thus QE which benefits primarily the rich is also lunatic.

    4. Adjusting interest rates is DISTORTIONARY: it channels stimulus into the economy primarily via investment. You might as well channel stimulus primarily via the motor industry, massage parlours and chewing gum makers. I.e. there is no reason for stimulus to skew the economy in any particular direction.

    5. We’ve just had a credit crunch caused by excessive borrowing and asset bubbles. And what do the authorities do? They cut interest rates and implement QE so as to – er – encourage borrowing and asset bubbles. The lunatics have taken over the asylum.

    6. Radcliffe Report on monetary policy in the U.K. published in 1960 concluded that ‘there can be no reliance on interest rate policy as a major short-term stabiliser of demand’.

    7. Apologies for overuse of the word "lunatic", but I can't help myself.

  6. Prof. Cochrane:

    I eagerly await your comments, as I know you'll give a thoughful essay/speech. What I would give to be able to hop on a plan and be there for your talk, and especially your Q&A session; i've been dying to ask you some questions in person.

    I would humbly ask you to pretend like I'm in the audience and these questions:

    1) What makes fed policy "easy" or "tight"? How would you describe fed policy since fall 2008?

    2) For those who argue that QE doesn't "work," what do they mean? If QE doesn't change expectations of inflation, why can't the Fed just purchase all outstanding US gov't debt and cancel it? Would you disagree that such monetization of the debt would cause hyperinflation?Surely there's some point between QE as it's been practiced and 100% monetization of the debt that would "work," no?


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.