Does money matter? The answer depends on who’s talking. Suffice to say, however, Milton Friedman’s dictum that inflation is always and everywhere a monetary phenomenon is now debatable in the academic community as well as in the board rooms of central banks around the world.
Consensus on the strategic answer for managing inflation appears to be fading. Michael Sesit at Bloomberg News has a nice essay today on some of the stress points that harass the subject of inflation theory these days.
In the academic world, there’s a relatively fresh dispute brewing about money’s role. On the one side are some who say that money supply is no longer relevant, or at least much less relevant in the battle for containing inflation. “Nowadays monetary aggregates play little role in monetary policy deliberations at most central banks,” observes Michael Woodford, a professor at Columbia, in a paper that’s forthcoming in the Journal of Money, Credit and Banking. “I have examined a number of leading arguments for assigning an important role to tracking the growth of monetary aggregates when making decisions about monetary policy,” he writes in “How Important is Money in the Conduct of Monetary Policy?” He goes on to report,
I find that none of them provides a convincing argument for adopting a
money growth target, or even for assigning money the “prominent role” that the
ECB does, at least in its official rhetoric. Of course, this is hardly a proof that no
such reason will ever be discovered. But when one examines the reasons that have
been primarily responsible for the appeal of the idea of money growth as a simple
diagnostic for monetary policy, one finds that they will not support the weight that
they are asked to bear.
This attack on money supply has spawned rebuttals of varying degrees, including a recent batch of opining from economists at the St. Louis Fed. For example, the title of Edward Nelson’s recent essay says it all: “Why Money Growth Determines Inflation in the Long Run: Answering the Woodford Critique.” Meanwhile, another St. Louis Fed paper (“Monetary Policy: Why Money Matters and Interest Rates Don’t”) argues, “Suggestions that the Fed can control prices without controlling the nominal stock of money (or final payment) are simply wrong.”
No one will take comfort from such debates, or that central banks around the world see the future in increasingly divergent terms. The Federal Reserve continues its preference for cutting rates and seeing the inflation risk as relatively tame. That’s in contrast to the European Central Bank and others, including the Reserve Bank of Australia, which anticipates higher inflation. Some of the variance in outlooks is due to local conditions, although cynics might say that local political pressures, or the relative lack thereof, are part of the explanation too.
It’s too soon to say that globalization has advanced to the point that the world economy is united and requires one monetary policy for all. Monetary policies, for good or ill, still vary widely and so to the extent that Friedman’s edict is accurate there will be and should be different inflation rates in different countries. Nonetheless, with the higher level of financial and economic integration, inflation exporting and importing is also easier than before. No central bank is an island in the 21st century.
In a sign of the times, the capacity for the migration of pricing pressures across political borders is stirring tension around the world, particularly in Asia. Increasingly, critics are pointing to the easy money policies in the U.S. as the source of the trouble. A Singapore-based media outlet argues that the “U.S. must stop using food for fuel.”
The optimists say that inflation will soon abate, in part because of the slowdown in the global economy. Perhaps. Meantime, monetary policy is in transition as policy makers grapple with a new era that enjoys precious little precedent. The outcome, in short, is still up for grabs and less than transparent. Hanging in the balance is inflation, and it’s impact on expectations.