Tuesday, May 22, 2007

Monetary Policy and Inflation (1)

A select committee of the New Zealand parliament is investigating new ways of managing the money supply. The reason for the renewed interest in monetary policy is that the Reserve Bank of NZ has increased the official cash rate (OCR) to 7.75%. The consumers price index (CPI) has crept above their target of one to three percent and the Reserve Bank is concerned that economic activity is getting too strong.

Adjusting interest rates is the only instrument available to the Reserve Bank. Home owners are becoming concerned as mortgage interest rates have increased to nearly 9 percent. People are claiming that the monetary policy is making housing unaffordable and causing problems for the economy. Exporters are complaining about the strong New Zealand dollar. Many pundits are suggesting that we need new ways of managing monetary policy.

There will be a lot of “huffing and puffing” about monetary policy, but the main truth will not emerge. What we will not be told is that monetary policy itself is a fraud.

The entire monetary policy edifice is built on several economic fallacies that need to be exposed. I will have a go at doing this in the next few posts.

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