Sunday, November 20, 2011

Monetary Policy Summary

We've just finished up monetary policy in class. One of the last things we covered was how stimulative monetary policy could become less effective when banks want to lend less and consumers want to borrow less. Basically you can't push on a string.

While I was describing this in class of Friday, the President of the Federal Reserve Bank of San Francisco was explaining it to other bankers at the Fourth Summit Meeting of Central Banks on Inflation Targeting in Santiago, Chile.

Why hasn't aggressive monetary accommodation fueled a rapid recovery in economic activity? I will focus on three powerful currents that have slowed the pace of recovery. The first is the massive destruction of wealth from the crisis brought about by the declines in house and stock prices. The second is the severe tightening of credit resulting from the financial accelerator mechanism, triggered by the decline in real estate prices and the upsurge in residential foreclosures. The third is heightened uncertainty regarding European sovereigns and the overall health of the financial system. These renewed concerns about the financial system have diminished the appetite for risk and sent investors fleeing to safe assets, such as U.S. Treasuries.

As they say, read the whole thing.

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