SWARAJ  

I have never understood one simple point – how can so called free marketeers defend fixing the price of money?

If they want to have government issued paper money backed by nothing, fine, then they must do two things – do not change its quantity (Except maybe adding a zero every ten or twenty years because of expected price deflation), and secondly, do not have capital gains etc taxes on other potential currencies – stocks, metals etc.

But they reply with two points – a) deflation is dangerous b) monetary policy is needed to smooth shocks because of price stickiness

on point a) deflation per se is not dangerous. unexpected, sudden and sharp deflation is dangerous. just like unexpected, sudden and sharp inflation is dangerous. heck unexpected, sudden and sharp almost anything is dangerous. if money supply is more or less fixed, prices will fall because of productivity increases – and since when did that start becoming a tragedy? And if there is indeed an external “Shock”, then prices will remain the same, they say – and this could lead to all kinds of catastrophes. This leads us to the next point

b) on point b, besides the points that activist monetary policy never works because of time lags etc., i do not believe prices are very sticky (this particular point that prices maybe very sticky has made mankiw, an otherwise freemarketeer into a “neokeynesian”). for example, nominal prices and wages might be fixed. but stores offer discounts, offers and other quality changes in store ambience etc. to manage inventory levels and match demand and supply. suppliers change benefits, delay or hasten improvements in working conditions etc. people may be hesitant to change nominal numbers because of sticker shock, but real prices and actual compensations change because often the product/labor conditions are changed instead. not to mention most of the stickiness there is, and this mankiw for example, acknowledges, is from government intervetions like minimum wages, overbearing product regulations etc.

take a) and b) along with a huge boost in currency derivatives and increase in floating exchange rates (which hedges risks for exporters and incentivizes private investors to capture seigniorage) and you donot really need any monetary policy at all. in my opinion, of course.

Update: Also, we should not try to to correct hardships like short-term poverty and unemployment through monetary policy. That is like, to use one of my favorite Chinese quotes, using a canon cto kill mosquitoes.

Use cash transfers, vouchers and other direct targeted subsidies to ease the short term pain (and all activist monetary policy advocates claim to be using monetary policy only for short term dislocations caused by external shocks – for the long term problems, even most of them do not advocate monetary policy). Because using monetary policy in such a manner might help the socio economic indicators for some time, but they create asset bubbles.

For example, each time I read the RBI modifying policy based on food inflation (which if often based on intrinsic demand supply factors, or if based on monetary factors – are often because of external monetary factors), I laugh at the pseudo-populism of this ostensibly independent institution.