Leads, lags and the monetary transmission mechanism

Leads, lags and the monetary transmission mechanism
Over the past three days Bob Hetzel has given a number of lectures in Copenhagen and I am happy to say that I have participated in all of the seminars and lectures. Not surprisingly Bob and I agree 90% (at least) on monetary theory, however, I have also become more aware of one of the major difference between traditional monetarism and Market Monetarism. Bob is a traditional monetarist and hence stress the development in monetary aggregates somewhat more than most Market Monetarists. I will readily admit that continue to think that monetary aggregate is very useful for analyzing the economic development - in contrast to Scott Sumner who mostly have given up on monetary aggregates and rather stresses the importance of market pricing and expectations. So the key innovation in Market Monetarism is the focus on markets and expectations rather than on monetary aggregates. The two views are not in conflict - at least not in my book - and should rather seen as complementing each other. Paradoxically the fact that Market Monetarists - partly like New Keynesians - stress the importance of markets and expectations actually means that Market Monetarists are even more optimistic about the power of monetary policy than traditional monetarists. This is best exemplified by Friedman's dictum that monetary policy works with long and variable lags. To contrast this Scott Sumner likes to say that monetary policy works with long and variable leads. Hence, Market Monetarists to a larger extent than traditional monetarists like Bob or David Laidler assume that economic agents are forward-looking and that rational expectations is a successful "approximation" of this behavior, while traditional monetarists never really have embraced rational expectations. Obviously, in Friedman's earlier work he assumed some kind of adaptive expectations as did other monetarists in the 1960s and 1970s. If expectations are adaptive then it will take time for economic agents to realize changes in monetary policy and as a consequence


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