There was not always a very strong consensus on the subject; for example, there was a debate about the impact of interest rates on inflation during the 1970’s. As shown in the chart above, higher interest rates have been associated with higher inflation. However, the empirical analysis done since then has been broadly interpreted as supporting the view that raising interest rates lowers inflation rates.
More recently, economists associated with Modern Monetary Theory have been arguing that monetary policy is relatively ineffective. This leads to the proposal by Mathew Forstater and Warren Mosler to lock interest rates at zero, as very little policy flexibility is lost in their view.
I will write a series of articles discussing this theme, as this is a critical subject for understanding monetary policy. At present, I am somewhat agnostic on the topic. Monetary policy is clearly effective under certain circumstances; conversely central banks as well as the markets have been incorrect about how stimulative the current regime of low interest rates would be. This does require a fair amount of empirical work, as theory can tell us very little about this topic, since we cannot know in advance the relative power of effects which act in opposite directions.
(NOTE: The list of articles below will be added to over time.)
Arguments That Interest Rates Are EffectiveReferences
- Monetary Policy In Theory And Practice Lars Horngren, Swedish Riksbank.
- How Monetary Policy Works, Bank of England. On that page, there is this pdf which has more detail on the transmission mechanism.
Arguments That Interest Rates Are Not EffectiveArticles
- The Natural Rate Of Interest Is Zero (Mathew Forstater and Warren Mosler).
- System Dynamics of Interest Rate Effects On Aggregate Demand, L. Tauheed and L.R. Wray.
(c) Brian Romanchuk 2013