1) Suppose the Fed increased interest on reserves from 0.25% to 8% tomorrow and simultaneously began a program to sell few trillion of the assets on it’s balance sheet and announced a new inflation target of 0%. What does the Book of Arnold predict will happen to inflation over the next two years?

2) Suppose the Fed cut the interest rate on reserves to -2%, announced a plan to buy an unlimited amount of financial assets until a market based forecast of NGDP 5 years from now reached $22.5T (5% year over year growth). What does the Book of Arnold predict will happen to NGDP over the next two years?

In fact, I would say that it is specifically the “cognitive illusion” that Scott mentions that allows the Fed to influence (though not control) the short-run path of interest rates…though I’m sure Scott would reply that the path and level of interest rates are an epiphenomenon generated by the Fed’s control of base money. And that there is no particular reason to focus on the particular variable.

In the same vein, MMTers focus heavily on the cognitive illusion of chartalism to motivate a positive value for legal tender…at least in the Wray model.

In the end, I certainly believe that the Fed has the power to steer the nominal economy. I believe this because others believe this, and that makes it true. That’s a far cry from saying that the Fed has iron clad control over the economy. I would also say that the Fed has the power and means to hit any nominal variable it wanted…unless we are running out of 1s and 0s…

on 2: but the causality runs entirely through the central bank. What would happen if the central bank chose not to inflate away the debt? The treasury would default on the debt.

1. The public decides what is money. We use plastic as money, we use paypal as money, we use money market funds as money, etc. The central bank does not control the supply of money that we actually use.

2. Central banks by themselves do not cause high inflation. High inflation is a fiscal phenomenon. When the government runs out of cheap credit but still runs a deficit, it starts printing money in great quantities, and that leads to high inflation.

3. The central bank controls its own balance sheet. But a private bank also controls its own balance sheet, and that does not determine macroeconomic performance. Unless the government is running an unsustainable deficit, everything the central bank does with its balance sheet can be accommodated by the private sector without any effects on long-term interest rates, inflation, or other macro variables.

I’m not speaking for Dr. Kling here, but I suspect I may “suffer” from the same lack of understanding of the monetarist model you reference as applicable to him. So perhaps I should do some more studying as well.

But I’m not exactly pathetically ignorant either. So before I ask you for a recommendation of where I should start studying the monetarist model, I should give you some idea of my pre-conceived notions, based on what seems to be portrayed as the monetarist model:

You reference, “… the quantity of money affects the real path of the economy”. You also state, “… the Fed lacks the ability to determine interest rates (other than its own discount rates).”

I agree wholeheartedly with both of those statements, as stated! (So perhaps I’m a “monetarist” after all.)

Of course the quantity of money affects the path of the economy. The thing is though, the quantity of money is not the only thing that affects the path of the economy. Nor is the quantity of money the economy in and of itself, as Scott Sumner seems to want me to believe. He advocates the Fed (or somebody) just “print up” an increase in the quantity of money until NGDP looks “pretty” – with “pretty” being defined by Sumner as somewhere between 4% and 5% NGDP growth rate. As compelling as that might sound for Sumner and others (after all, who doesn’t want robust GDP growth?), I don’t consider just making NGDP look “pretty” by way of the expedient of adding more money a worthy macroeconomic goal in and of itself. As Dr. Kling has said (and I concur), “the U.S. economy is not just a GDP factory.”

I also agree that the Fed doesn’t have the ability to determine interest rates other than its own. I would also quickly add that the Fed doesn’t even have the responsibility of determining interest rates other than its own. I suspect that is the issue that Dr. Kling (and I, and others) have always known, but Scott Sumner apparently has just “stumbled upon” – the point of this post by Dr. Kling.

So where should I begin my study of the monetarist model to improve upon my understanding? Any recommendations?