Monetary Policy in a Low R-star World
John C. Williams
FRBSF Economic Letter 2016-23 | August 15, 2016
Central banks and governments around the world must be able to adapt policy to changing economic circumstances. The time has come to critically reassess prevailing policy frameworks and consider adjustments to handle new challenges, specifically those related to a low natural real rate of interest. While price level or nominal GDP targeting by monetary authorities are options, fiscal and other policies must also take on some of the burden to help sustain economic growth and stability.
As nature abhors a vacuum, so monetary policy abhors stasis. Instead of being a rigid set of precepts, it follows the adage, that which survives is that which is most adaptive to change. Over the past century, monetary policy strategies have evolved in response to changing realities, from the panics and depressions of the late 19th and early 20th centuries that led to the creation of the Federal Reserve to the Great Depression, from Bretton Woods and subsequent battles to contain inflation to the dominance of inflation targeting today (Williams 2014, 2015a).
In the wake of the global financial crisis, monetary policy has continued to evolve, in this latest incarnation battling low inflation and stagnation via unconventional monetary policy actions like quantitative easing and near-zero or even negative interest rates. As we move forward, economic conditions require that central banks and governments throughout the world carefully reexamine their policy frameworks and consider further adjustments in terms of monetary policy strategy—both in its own right and as it relates to other policy arenas—to successfully navigate these new seas.
All the economic world’s a stage: The roles of monetary and fiscal policy
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