It's a rare occurrence to discover an intellectual kindred spirit, yet last week I did so - during an episode of “Q and A” of all places!
On last week's episode of “Q and A” in response to a question on the topic of retrofitting office buildings, comedian and monetary policy scholar Luke McGregor, instead smoothly pivoted to talking about his view on the impulse response function of monetary policy shocks on the inflation rate (precisely zero according to his best estimates).
Ask yourself, dear reader, who else when given a platform on national TV would take the opportunity to discuss the intricacies of monetary policy and the rate of inflation regardless of the question actually asked!
Only some truly dedicated to the niche topic that is Australian monetary policy that’s who. And I cannot help but admire his chutzpah.
It’s a shame then that his answer was completely wrong.
Not right
The bulk of the literature on monetary policy is fairly clear cut on this issue. Contractionary monetary policy leads to lower inflation over time.
Now finding misconceptions about monetary policy is not a tough task. Misunderstandings and flat out errors are everywhere, from gold bugs to Utopianist who deny economic constraints. But this example made me wonder, how might someone with a bit more expertise in this field respond to this sort of claim in such a setting. Of course pulling out a copy of Woodford (2003) is not feasible on live TV. Is there a simple, concise explanation that can be spun out in a 20-second Q&A format? How can one counteract this sort of misinformation within a short soundbite?
To me, the most straightforward method of explaining the transmission of monetary policy to the general public is through the exchange rate. Australians, familiar with international travel and reliant on numerous imports, understand how fluctuations in the Australian dollar influence their cost of living. The immediate reactions of the exchange rate are perfect examples of a well-identified monetary policy shock as well.
And this mechanism is best illustrated with an example.
So I think the best response would go something like this:
In May the RBA surprised everyone by hiking interest rates by 0.25%. In response the Australian dollar immediately surged in value climbing 1% overnight! This appreciation may not seem significant, but it means the price of every good that Australia imports will become 1% cheaper. Cheaper cars, cheaper petrol, cheaper medicine, and even cheaper iPhones. These are all goods that Australian households use on a daily basis. That is but one way that this single interest rate hike helped lower the rate of inflation in Australia.
This explanation is by no means exhaustive; numerous other monetary policy channels affect the economy - the housing market, business investment, government spending, to name just a few. But the exchange rate and its reaction to the surprise policy change in May provide a clear and simple example that I think most lay people would understand.
Of course it's essential to note, though, that the 1% appreciation of the exchange rate won't instantly affect prices, at least not for all goods. The price of imported clothes at Big W won't change overnight, but in the coming months, we should expect imported goods to be 1% cheaper in Australian dollar terms, all else being equal.
Wolfgang Paul, a theoretical physicist, infamously described a particularly poor piece of work as "Not only not right; it is not even wrong". Luke McGregor may be not be right, but at least he is willing to take up a microphone and force the Australian public to listen a discuss of how monetary policy affects inflation. For that dedication I think we can all forgive him the minor sin of merely being wrong.
The exchange rate is a good example, consistent with Sumner's price of money approach. His claim probably has it origins in the various price/interest rate puzzles found in the literature, but I suspect most of those puzzles stem from their reliance on official interest rates as a measure of the stance of monetary policy. If that stance is incorrectly identified, it is no surprise that the IRFs make no sense. See my review of Sumner: https://stephenkirchner.substack.com/p/book-club-scott-sumners-alternative