Edited by William F. Shughart II and Laura Razzolini
Chapter 21: Monetary policy
Mark Toma 1 Introduction The money market of modern theory is plagued by problems. The traditional economic solutions have been magic wand ones – magic monetary wands. For instance, monetary theorists have devoted much attention to the problem of a determinate general price level. The problem here is that holders of money cannot establish their current demand without knowing the current supply and whether it will be augmented in the future. The upshot is that today’s price of money and, hence, the general price level, depends on current and all future supplies. So the problem of a determinate price level is fundamentally an issue of whether money holders are able to anticipate the future time path of money. The monetary economist is quick to supply the magic wand: assume a deterministic process for generating current and all future money supplies. More imaginatively, the magic monetary wand may take the form of Milton Friedman’s famous helicopter or a conservative central banker who comes pre-equipped with a well-deﬁned and immutable set of anti-inﬂation preferences (Rogoff 1985). These solutions are alike in that they solve monetary problems by introducing a supply factor from outside the model. A major theme of this chapter is that the public choice approach to monetary policy offers more satisfactory solutions because it does not involve wand waving. By modeling the incentives that real-world central bankers confront, the public choice approach is able to make the supply of money endogenous. This is real progress. A key measure of...
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