Monetary Policy for Dummies

Monetary policy is a deep subject, one many people don’t understand (including some Nobel-prize-winning economists). I believe monetary policy is probably more important than national politics, so I hope you’ll want to spend some time to learn about it. The three main schools of thought of monetary policy are …

  • Keynesian: The government can control monetary policy largely through adjusting interest rates and fiscal (government) spending. While the central theory has been abandoned, a New Keynesian school has tried to adjust to better conform to reality (like stickiness — see below). New Keynesians like Greg Mankiw are helping adjust the theory and are making positive contributions.

  • Austrian: The Austrian school, which started in Austria but is now worldwide, is based on two fundamental concepts: laissez-faire capitalism and marginalism. They don’t believe governments should be in control of markets or money at all, except to enforce fair dealing.

  • Monetarist: Monetarists today continue the work of Milton Friedman. Friedman said that long-term inflation is always a monetary phenomenon and that fiscal policy had almost no leverage on the economy. He promoted policies that pursue a long-term target of a small amount of inflation by adjusting the money supply, to keep the economy growing. A subset of this school is market monetarism, which proposes adjusting the money supply to compensate for swings in aggregate demand.

Tyler Cowen and Alex Tabbarrok have created a fantastic set of online courses on economics called Marginal University. I recommend their course on macro economics.

Here’s the first video to get you started.