Notes for a Talk on Teaching the Very Basics of Monetary Policy...

Notes on teaching the very basics of monetary policy

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Teaching Monetary Policy

Bradford DeLong

November 3, 2006; Amelia Island, FL

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The Federal Reserve Acts:

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We Would Like Our Students to Be Able to Read the Wall Street Journal:

Like http://online.wsj.com/article/SB116179074182303451-search.html?KEYWORDS=bernanke&COLLECTION=wsjie/6month

Greg Ip:

Mr. Bernanke has faced shifting challenges since taking office. Core inflation has risen to 2.9% from 2.1%, the highest level in a decade…. That led the Fed to raise rates at its first three meetings under Mr. Bernanke…. [E]conomic growth, under the weight of falling home and automobile sales, began to slow, to an estimated annual rate of about 2% in the third quarter. That would be the second-lowest level since 2003. In recent weeks, though, both inflation and growth worries have eased. Energy prices have plunged, and the Fed expects the indirect impact of that drop to pull down core inflation in the coming year or so. Yesterday's Fed statement dropped a reference from the previous month to energy and commodity prices as a source of inflation pressure. There is little sign the economy outside housing and cars has slowed much...

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What We Want to Teach Them So They Can Do So?

Federal Reserve objectives:

• Effective price stability *Given that, unemployment as low as possible--at the natural rate

Federal Reserve tools:

• Controls short-term, safe, nominal interest rates

Economic environment:

• Term structure: what matters most are long-term, real, risky interest rates
• Which affect investment spending (primarily construction) and exports
  • Multiplier *Long and variable lags

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How Do We Teach Them?

• Keynesian cross?
  • Is it worth spending time on the multiplier?
• AS-AD?
  • What gives the AD curve its downward slope?
• Quantity Theory of Money?
  • How to get from MV=PY to the Fed announcements?
• IS-LM?
  • Too complicated for Principles--which means not retained well in intermediate…

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And How Do We Get Them to Retain Enough to Be Economically Literate?

To be able, for example, to talk coherently about U.S.-China economic relations:

• Trade side:
  • Gains from trade…
  • Long-term political benefits from a richer and more democratic China…
  • Long-term political costs…
  • U.S. manufacturing employment…
  • Other U.S. distributional issues
• Macro side:
  • Crowding in via PBoC purchases of U.S. Treasuries and other assets…
  • Cost of repaying foreign debt…
  • Possibility of foreign-exchange crisis…
• Need to connect the syllabus up to the issues: How?

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For McGraw-Hill Amelia Island, FL conference, Nov. 2-4, 2006

Comments

[wkwillis]

The problem with the chart above is that it measures only nominal short term interest rates. It does not measure real short term interest rates.
Nor does it go back far enough to show the Fed's increasing real interest rates before the 2000 election, and the Fed's lowering of real interest rates after Bush became president. Real interest rates have been declining all through his term. Indeed, the chart above makes it look as if interest rates were actually going up in Bush's second term.

[Ponzi Q. Globalization]

This point should be added to the trade section:

* Global labor arbitrage -- A single global labor market in a world with vast differences in living standards helps the majority of workers in the wealthier nations.

[Barkley Rosser]

I am a defender of teaching the multiplier. For one thing it probably is about 2 in the US economy. Another is that first round effects are heavily localized. This explains a lot of things that are not necessarily obvious otherwise, e.g. why all local chambers of commerce support protection for a major local industry. If it were not for multiplier effects, they might be looking pleasurably upon the lower wages they could pay in their local labor markets.

Also, it is easy to reconcile the Keynesian cross and AS-AD. Just do the Keynesian cross in nominal terms. Multiplier effects still happen even in the "classical zone" of an AS. They just happen as purely price effects, that's all.

Wealth effects, international substitution effect, and the Keynes effect through interest rates all give a downward sloping AD.

[theCoach]

What would be the optimal rate at which we could elevate China's living standards to the point where they required the same amount of energy use as the average American?

[andres]

theCoach: if I remember correctly, there is a proposition incorrectly called the Daly Impossibility Theorem that says that worldwide consumption on the US scale is impossible in resource and environmental terms. And China is a pretty large slice of the world population any way you cut it.

[Ian Whitchurch]

Start with the abolute basics - whats money.

Then talk about metallic currencies.

Then talk about metal-backed currencies (are there any left ?).

Then modern paper money.

Then M1, M2 etc.

Ian Whitchurch

[wkwillis]

Well, China can elevate it's consumption to our level, if it doesn't consume the same things we do. They could build battery cars to avoid consuming oil, and wind and solar and nuclear power to avoid emitting carbon compounds. Then their primary constraint left would be fish, grain fed beef, and lumber.
They would have to pour huge amounts of money into food production projects like genetic engineering of minor crops to avoid the agricultural productivity bottlenecks we are running into now.
But reducing paper consumption is something I have trouble with. Maybe genetic engineering of grass for paper and wood products?
But where will they get so much fish? Maybe we will get more fish if the Arctic ice caps continue melting?