The failure is not in our stars but in our analogies

Loose monetary policy analogies focus on excess. The punchbowl is a favorite in which excess alcoholic punch is being made available to the market\economy party. In context, providing more punch to the party is irresponsible behavior. The analogy is tenuous when you reverse it; not providing enough punch doesn’t really seem like a problem. To hold to the analogy, the party gets boring.

A more useful analogy it seems to me is the economy as an engine and monetary policy as oil in the engine. What we can hope to accomplish with monetary policy is enough oil in the engine that the engine can perform well. Too much oil in an engine doesn’t make it perform better, and at some level makes it perform worse. Too little oil makes the engine perform worse with extra wear on the engine and eventually it seizes. In reality the engine in question, the economy, is dynamically sized. It can grow or shrink. We don’t know how big the engine is at any time we mostly have suggestions as to what size it is and how it is growing.

This where it makes sense to question how much oil we should be putting in an engine of unknown size and growth rate. That seems to me to be the point where we talk about NGDP targeting and futures markets. At the moment this is the most promising way to solve that problem. See Scott Sumner and his blog the Money Illusion for better insight than I can provide on those topics.

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