Here’s a recent restatement by James Alexander, at Marcus Nunes’ blog, of one of the tenets of market monetarism. That monetary policy – via financial markets – has its effects instantaneously, always, and that the ‘long and variable lags’ commented on by Milton Friedman, which this blog is named after, are a figment of mainstream monetary economists’ imaginations.
“Many conventional macroeconomists still cling to the notion of “long and variable lags” before the impact of changes in monetary policy have an impact…. They could not be more wrong. Markets do the heavy lifting, the signalling, the changed expectations, instantaneously. The rest is history, or rather the inevitable playing out of those expectations in terms of high or low inflation, or rather high or low nominal growth. Of course, expectations can change as central bankers shift their views but often they get stubborn, with disastrous consequences.”
This is an intriguing, utopian view, stated before by Scot Sumner, the chief of the market monetarist tribe. Unfortunately, there’s just no evidence in favour of it.
Dozens of applied macro economists, perhaps even hundreds, have been working on how to identify the effects of monetary policy changes. The research came in several waves, as the profession thought more and more deeply about the difficulties of separating out the effects of monetary policy changes from the effects of monetary policy simply responding to other things going on in the economy.
But without exception – at least in the modern and best incarnation of this research – the lags are measured to be ‘long’. That is to say, there may be some small effect that comes through quickly, but most doesn’t, and the peak effect of monetary policy is measured to come between 1 and 2 years after the change. A classic survey from 1999 is this paper by Christiano, Eichenbaum and Evans. But there has been a torrent of work since, reconfirming this basic message.
And those studies that look into their variability – me included – find that they are, though the jury is probably still out on whether that variability is fact, indicative of a shifting economic structure, or artefact.
That’s not to say that the effect of expectations is not important. On the contrary. And those that have actually tried to disentangle the effect of expectations changes on the economy find such effects, and, lo and behold, those lags are long too. [I’m not aware if anyone has looked into whether they are variable, but knowing how such things are done, my guess is that we would also find that they are, with the same qualifications as to what one infers from that].
There are plenty of controversies in this literature. But that there are substantial lags in monetary policy is not to my knowledge one of them.