Was Fischer Black right about monetary policy?

That is the topic of my latest Bloomberg column:

Paul Krugman has argued that there was not high inflation after 2008 because the U.S. economy was in a liquidity trap. Black’s rejoinder to the Keynesians was a subtle one: We are always in a liquidity trap. Since banks can bid for reserves, and reserves can pass in and out of banks freely, the net value of additional bank reserves must be equal to other uses of the funds. The monetary expansion of the U.S. Federal Reserve, which operates through banks, is thus like swapping two nickels for a dime. Whether or not nominal interest rates are zero, after the swap banks can still move back to whichever portfolio they wished to hold. Thus any Fed actions will prove neutral if that is what the banks, and the economy as a whole, desire.

And the accompanying footnote?

  1. Both market monetarists and Keynesians admit that in a traditional liquidity trap, monetary policy still can be effective if the Fed can make credible promises to inflate. I regard this as a substantive concession to the Fischer Black view, even if it is not usually presented as such.


I can’t quite bring myself around to the Fischer Black view on inflation. I was brought up believing in a well-defined quantity of money that causally determines the price level, and I still see central banks commanding a lot of attention from the markets. Nonetheless, as central banks rely more on market expectations to orchestrate macroeconomic outcomes, I no longer see the Fischer Black views as so far from the current mainstream.

Black formulated his basic arguments to cover open market operations, as in his time such fine practices as tri-party repo did not have their current import.  What exactly does the Black argument look like for current times?  What are the exact mechanisms for “the market undoes the actions of the central bank” and how plausible are they?


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