The long tail of Monetary policy

This really is a fun time to be teaching macroeconomics.

First, the US:

Employers in the U.S. hired more workers than forecast in November, and the unemployment rate was unchanged, suggesting the labor market may be strong enough to keep the economy from tipping into recession.

Payrolls rose by 94,000 after a 170,000 increase in October, the Labor Department said today in Washington. The jobless rate remained at 4.7 percent for the third month in a row.

The jobs report will be “a linchpin” in the Fed’s rate deliberations on Dec. 11, John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, said before the report. Silvia said a payrolls figure between 80,000 and 100,000 would justify a quarter percentage-point cut in the Fed’s benchmark rate next week.

Leaving aside the fact that the forecasts were clearly bad; 94,000 really isn’t much (don’t forget, a hell of a lot of people hit the labour force, every month).

Next: the UK:

The Bank of England, struggling to fend off an economic slowdown, may instead be giving itself a new inflation headache.

“There’s a risk the Bank of England is going soft on inflation,” said Dominic White, an economist at ABN Amro Holding NV and a former U.K. Treasury official. “For the last five or six years, the bank has shown willingness to cut rates, but has been slow to raise when the economy had recovered.”

The reduction, the first in two years, may make it harder to keep consumer prices under control. Britons’ expectations for the cost of living are the highest in two years, and inflation accelerated above the central bank’s 2 percent target for the first time in four months in October.

If nothing else we should learn to (i) hate capital funds, (ii) hate central banks for the entropy they allowed idly to occur, in their responsibilities to financial market stability, and (iii) appreciate the Austrian school.

Anyway. This is an example of one of the real tricks with using Monetary policy: it has a long tail. The full effect of a change in the rate of interest can take anything from 6 to 18 months to take effect – this is why Monetary policy is the poorer one (the other being Fiscal) to be used for pushing Aggregate Demand. Specifically (and returning to our textbook): what is being risked is this scenario:

1) An ordinary Business cycle, in which we find ourselves in a slump/recession (i.e. the trough):

Click for bigger versions
monetary 1

2) Our central bank starts lowering interest rates, to spur growth, but they did it too late:

monetary 2

3) As a result, they make subsequent inflation and over-investment worse.

monetary 3

Quite a few people, in fact, are pinning things like this mess, as well as the blippish recession in 2001/2 on Greenspan’s Fed, for doing exactly that. The Brits – particularly those who had to live through Thatcher – are very sensitive to the risk of something like that revisiting them.


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