Determining Monetary Policy's Effects on the Economy Is Problematic, Says Atlanta Fed Study
Business news often gives the impression that the effects of monetary policy on the macroeconomy are well understood and predictable. Policymakers and economists, however, are far from sharing such certainty because they face difficulties in sorting out causal factors in economic data, according to an article in the Atlanta Fed's Economic Review.
Author Eric M. Leeper, a former research officer with the Atlanta Fed and now on the economics department faculty at Indiana University, believes that monetary policy effects are neither well understood nor easily predicted. "Even though most economists agree on the qualitative effects of monetary policy, they disagree on its quantitative importance," he writes. Despite this lack of consensus, policy advisors must interpret economic developments and formulate policy advice.
Leeper's article is intended to illustrate the role that identification -- a process applied whenever data are interpreted in terms of economic behavior -- plays in policy analysis. He presents five models of private and monetary policy behavior in the United States. Identical policy experiments -- an unanticipated one-time monetary policy contraction -- performed in each model show different qualitative and quantitative effects of policy from one model to the next.
After considering a variety of methods for ranking the models according to their plausibility, Leeper concludes that each model has some limitations. Because of these problems, he suggests, it would be wise for policy advisors to be eclectic in choosing models for formulating advice.