Opposing Views of the Effectiveness of Monetary Policy
Monetary policy is a powerful governmental weapon which has historically proven that it is difficult to wield. This difficulty is one of the reasons why some economists doubt the effectiveness of monetary policy as a whole. These economists find that monetary policy is difficult to implement because of estimation problems and time lag problems, as well as cyclic effects. They also point out situations in which monetary policy may not work at all. On the other hand, some economists swear by monetary policy as one of the most influential economic tools. These economists show that controlling money supply in America is a relatively young idea, and is developing rapidly. They also attempt to show that money supply affects many variables in our economy, and that it is useful in more situations than the anti-monetary policy economists, Keynesian economists, would have us believe.
To gauge the ineffectiveness of monetary policy some economists call our attention to the great depression. How could governmental monetarists allow one quarter of the country to be unemployed or for one third of commercial banks to be put out of business by “bank panics?” People who took part in these bank panics were not only taking out their “own” money, but were taking out possible loans for others (the amount they took out multiplied by the money multiplier) which eventually became 31% of the total money supply. The economist best fit to use monetary policy would be able to tell the future, or at least provide a pretty good estimate. These estimates are very difficult when sometimes the results of policy actions are not seen for months to over a year. Corrections of these actions could take just as long, sending the country for a roller coaster ride. “Milton Friedman, lifelong foe of the Federal Reserve System” blames the “Fed” for their inaction during the great depression. Had the Fed raised the money supply during the depression perhaps more banks would be able to survive, unemployment would drop, and the U.S. would pull itself out of the depression much sooner and quicker than it had. The failure to act was probably due to the immaturity of monetary policy at the time, and perhaps learning from the past is the best we can do. There is still, however, the fact that it takes great estimation skills to use monetary policy effectively, and this provides doubt for the effectiveness of the Fed’s actions concerning money supply. There is also a time lag associated with monetary policy. The fed had raised the discount rate too late in order to slow down the stock market boom of 1929. The ill timed raise of the discount rate did contract the money supply; however, it did so during the stock market crash, making the entire situation a whole lot worse. This time lag in the policy’s effect helps to magnify the estimation problem.