Wednesday, March 19, 2008

Krugman on Monetary Policy

An op-ed columnist of the New York Times, Paul Krugman, tells about the recent monetary policy conducted by the Fed.

First, he talks about the fundamental theory of monetary policy:

The Fed’s economic power rests on the fact that it’s the only institution with the right to add to the “monetary base”: pieces of green paper bearing portraits of dead presidents, plus deposits that private banks hold at the Fed and can convert into green paper at will.

When the Fed is worried about the state of the economy, it basically responds by printing more of that green paper, and using it to buy bonds from banks. The banks then use the green paper to make more loans, which causes businesses and households to spend more, and the economy expands.
This process can be almost magical in its effects: a committee in Washington gives some technical instructions to a trading desk in New York, and just like that, the economy creates millions of jobs.

But sometimes the magic doesn’t work. And this is one of those times.

And then, Krugman talks about the recent situation of economy:

....But the Fed is trying to contain the damage from the collapse of the housing bubble, keeping it from causing a deep recession or wrecking financial markets that had nothing to do with housing.

So Mr. Bernanke and his colleagues have been doing the usual thing: printing up green paper and using it to buy bonds. Unfortunately, the policy isn’t having much effect on the things that matter. Interest rates on government bonds are down — but financial chaos has made banks unwilling to take risks, and it’s getting harder, not easier, for businesses to borrow money.

As a result, the Fed’s attempt to avert a recession has almost certainly failed. And each new piece of economic data — like the news that retail sales fell last month — adds to fears that the recession will be both deep and long.

Reading the above article, we can recall another similar story. So, it's about Japan: Japan also had a long and deep recession and the monetary policymaker didn't pull Japan from such terrible anxiety.

Now is the time we should get a good lesson from Japan!

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