The Fall 2020 issue of the Cato Journal covers several key topics in monetary policy: (1) the risk to the Federal Reserve's independence and credibility as it drifts into fiscal policy; (2) the effectiveness of negative interest rates as a tool of monetary policy; (3) the impact of financial transactions taxes; and (4) the lessons that can be learned from the classical gold standard.
The Fed's use of unconventional monetary policy has greatly expanded its balance sheet and engaged the Fed in credit policy that is ripe with fiscal implications. Esther George, president and CEO of the Federal Reserve Bank of Kansas City, explores some of those implications in her tribute to Marvin Goodfriend, who sadly passed away last December. She concludes that Goodfriend was "keenly focused on preserving the central bank's integrity and independence"—a view that "undoubtedly would serve us well today."
Since the global financial crisis in 2008, negative interest rates have taken the policy world by storm. Most notably, they have been a popular point of contention between Federal Reserve Chairman Jerome Powell and President Donald Trump. To shed light on some of the issues at stake, Swedish economists Fredrik N. G. Andersson and Lars Jonung, professors at Lund University, analyze the Riksbank's experience with negative interest rates from 2015 to 2019. In doing so, they draw lessons for other central banks that are considering turning to negative rates to boost inflation and spur their economies. With respect to the United States, they conclude: "Evidence from Sweden suggests that negative policy rates in the United States would lead to a rapid increase in housing prices, greater demand pressure, and a depreciating dollar, with only minor effects on consumer inflation rates."
In addition to negative interest rates, the global financial crisis also spawned an ongoing discussion of using financial transaction taxes (FTTs) to stabilize financial markets. Diego Zuluaga, associate director of Cato's Financial Regulation Studies, considers the arguments for and against FTTs. He concludes that they typically raise little revenue and increase the cost of capital, thereby distorting financial markets.
Finally, I argue that the classical gold standard, if properly understood, can help inform monetary policy. It is not, as many claim, "a nutty idea." Rather than relying on central bank guidance, the pre-1914 gold standard, which defined the dollar as a physical quantity of gold, anchored the long-run price level and stabilized exchange rates. It also discouraged resort to debt monetization. Whether one favors a gold standard or not, it is a mistake to dismiss the value of those attributes.
Abstracts of these four articles follow. Jump directly to the Cato Journal to read them and seven other excellent articles covering issues unrelated to monetary policy.
By Esther L. George
Marvin Goodfriend (1950–2019) was keenly focused on preserving the central bank's integrity and independence. I share several concerns with Marvin. To the extent that large-scale asset purchases succeeded in their aim of creating a wealth effect, they also played some role in contributing to elevated asset valuations. These effects, together with the perception that interest rates will remain at historically low levels for a prolonged period, can lead to a buildup of financial imbalances that ultimately pose risks to the real economy. Another concern I share with Marvin is the risk that income from the Fed's large balance sheet combined with our capital surplus could tempt fiscal authorities to view the Fed as a source of funding for government programs. Central bank independence requires that a bright line exist between monetary and fiscal policy. Marvin therefore proposed that the 1951 Treasury-Federal Reserve Accord on monetary policy be supplemented with a Treasury-Fed Accord on credit policy.
By Fredrik N. G. Andersson and Lars Jonung
Negative interest rates were once seen as impossible outside the realm of economic theory. However, several central banks have recently adopted negative policy rates. The Federal Reserve is coming under increasing pressure to follow suit in the wake of the coronavirus crisis. This paper investigates the actual effects of negative interest rates using the Swedish experience from 2015 to 2019. The Swedish Riksbank was one of the first central banks to introduce a negative interest rate in 2015 and the first central bank to abandon a negative rate in 2019. We find that negative rates had a modest effect on consumer price inflation due to globalization, but significant effects on the exchange rate and domestic asset prices, thus fostering financial imbalances. We conclude by discussing the implications of our results for larger economies such as the United States. Our view is that the lesson from Sweden is clear: a negative central bank policy rate is not a panacea.
By Diego Zuluaga
Financial transactions taxes (FTTs) have become a plank of the Democratic policy platform, part of a global resurgence of FTTs since the 2008 financial crisis. While politicians argue for them as a way to raise revenue, economists regard FTTs as inefficient for that purpose because of the behavioral changes they cause. Instead, John Maynard Keynes and James Tobin, among others, proposed FTTs precisely to discourage transactions and thereby reduce the supposedly destabilizing effects of "excessive" trading. But evidence from around the world shows FTTs' impact on market efficiency to be ambiguous, as they sometimes increase volatility and hamper price discovery. FTTs also raise very little revenue because listed firms and traders move to other jurisdictions in response to the tax. Imposing an FTT in the United States would be particularly harmful during the present crisis, as it would raise the cost of capital for firms struggling to adapt to the post-COVID-19 environment.
By James A. Dorn
The operation of the classical gold standard offers many lessons for policymakers, including ones concerning the consequences of a credible commitment to a rules-based monetary regime and to enforceable private contracts under a just rule of law. These lessons don't mean we should necessarily return to a gold standard, but they do suggest that we should not dismiss the gold standard as a "nutty idea." The gold standard should be understood as one approach for attaining monetary stability. It is a rules-based system that brings about long-run price stability via market forces and the free flow of gold. It is also a monetary regime that is consistent with individual freedom and the rule of law. The real gold standard ended in 1914.