Revisiting Three Intellectual Pillars of Monetary Policy

There are good reasons to question three deeply held beliefs underpinning monetary policy received wisdom. First, defining equilibrium (or natural) rates purely in terms of the equality of actual and potential output and price stability in any given period is too narrow an approach. An equilibrium rate should also be consistent with sustainable financial and macroeconomic stability—two sides of the same coin.

Second, money (monetary policy) is not neutral over medium- to long-term horizons relevant for policy—that is, 10–20 years or so, if not longer. This is precisely because it contributes to financial booms and busts, which give rise to long-lasting, if not permanent, economic costs.

Finally, deflations are not always costly in terms of output. The evidence indicates that the link comes largely from the Great Depression and, even then, it disappears if one controls for asset price declines.

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