Saturday, June 18, 2022

Monetary Policy

Monetary policy is a powerful tool, but it is a very blunt instrument, so the central bankers who use it have almost no control over the direction it will hit. They have very little control of what sector of the economy it will it affect. This is a serious weakness with the tool.

Over the last decade, central banks have kept interest rates low to prevent the pandemic from doing too much harm to the world economy. Their policy may have helped, but most of the effect of this weak monetary policy fed into share markets and housing markets, producing serious house price inflation and booming equity prices. This mostly benefit people who are better off.

Now that inflation has become a problem, central bankers are tightening monetary policy by pushing up interest rates. The problem is that the tightening on the way down does not always go in the same direction as the loosening on the way up.

Tight money policy might bring down share prices and house prices causing pain for the relatively well off, but it might affect the productive economy far more than it did on the way up. In attempting to bring the inflation that they deliberately created back under control, central banks might do terrible harm to the productive capacity of the economy that the poorer people of the world depend on.

Central banks are serious about tightening money policy, but they done really know how it will feed through the economy and which sectors will be affected most.

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