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Joe Gagnon: Understanding 21st Century Monetary Policy

Joe Gagnon: Understanding 21st Century Monetary Policy:

Monetary policy consists of printing money to buy assets. This is true whether the aim is to lower the federal funds rate, the mortgage rate, or any other rate of return. Fiscal policy consists of selling assets to buy goods, cut taxes, or increase transfers…. Central banks have always held risky assets…. Conducting monetary policy when short-term interest rates are near zero requires central banks to take on more risk, but this is only a difference of degree and not of kind....

A recent outpouring of research confirms that central banks do have the ability to influence long-term bond yields and mortgage rates significantly. There is no reason to doubt that central bank purchases of equity or real estate could significantly influence the prices of those assets. Indeed, the Hong Kong Monetary Authority conducted a spectacularly successful stabilization of the Hong Kong stock market in 1998 during the Asian financial crisis. Macroeconomic models suggest that central bank purchases of long-term bonds and other risky assets can provide significant macroeconomic stimulus. Moreover, as I discussed in a previous blog post, the risk of losses to central banks that undertake such purchases is small compared to the overall fiscal benefits….

The only question is why the major advanced-economy central banks have been so timid in using their powers and allowed inflation—and for the United States, employment—to fall below their targets.