Monetary economics.

• Author: Romer, Christina D.
• Position: Program Report

The subject matter of monetary economics encompasses a large part of macroeconomics. Most obviously, monetary economics is concerned with the conduct, effects, institutions, and history of monetary policy. But it extends far beyond that. The sources of aggregate fluctuations, the channels through which changes in monetary policy and other developments are transmitted to the macroeconomy, and households' and firms' decisions about consumption, investment, prices, and other variables that are critical to aggregate fluctuations are all important subjects in monetary economics. Indeed, the unofficial working definition of "monetary economics" that is used by the NBER's Program in Monetary Economics is "anything that central bankers should be interested in." Examples of recent work in the program that is not explicitly about monetary policy but that falls squarely within the program's mandate include research by James H. Stock and Mark W. Watson on forecasting inflation (12324); research by Christopher House and Matthew D. Shapiro on the effects of temporary investment incentives (12514); research by Michael W. Elsby on downward wage rigidity (12611); research by Andrew Ang, Monika Piazzesi, and Min Wei on using interest rares to forecast GDP growth (10672); research by Francis E. Warnock and Veronica C. Warnock on the impact of purchases of U.S. government bonds by foreign central banks on U.S. interest rates (12560); and much more.

Researchers in the NBER's Program in Monetary Economics contribute to our understanding of monetary economics by conducting empirical and theoretical studies of a wide range of subjects within the broad field of monetary economics. These studies are issued as NBER Working Papers, and presented and discussed at regular meetings of the program and at special NBER conferences devoted to particular subjects related to monetary policy. The studies are subsequently published in NBER volumes and in academic journals.

Although the greatest long-run influence of the members of the Monetary Economics program is surely through their research, they also have a very tangible, immediate influence through an entirely different channel: former members of the program hold key positions at central banks throughout the world. Most obviously, former NBER Research Associate (and former Director of the Program in Monetary Economics) Ben S. Bernanke took office as the eighth Chair of the Board of Governors of the Federal Reserve System in February 2006. In addition, program member (on leave) Mervyn A. King is the Governor of the Bank of England; program member Stanley Fischer is the Governor of the Bank of Israel; program member (on leave) Janet Yellen serves as President of the Federal Reserve Bank of San Francisco; program member (on leave) Frederic S. Mishkin is a member of the Federal Reserve Board of Governors; program member Lars E.O. Svensson is a Deputy Governor of the Riksbank (Sweden's central bank); and program member David G. Blanchflower is a member of the Monetary Policy Committee of the Bank of England.

Program members also interact frequently with monetary policymakers. These interactions serve to keep program members abreast of developments in monetary policymaking, and to allow policymakers to convey to NBER researchers their views about what issues are currently important to them. Traditionally, one session at the program's meeting during the NBER's Summer Institute is devoted to a discussion with a policymaker. Policymakers who have met with the group in recent years include Ben Bernanke (both in 2003, when he was a member of the Board of Governors, and in 2007, was he was chair), Stanley Fischer, Donald Kohn (when he was a member of the Board of Governors; he is currently its vice-chair), N. Gregory Mankiw (when he was chair of the President's Council of Economic Advisers), and Janet Yellen.

In this report, we provide an overview of some of the lines of research that have been pursued in the program in the past few years. As the previous discussion suggests, however, the work done in the program is so diverse that we can only discuss a small part of it.

The Zero Lower Bound on Nominal Interest Rates

When the central bank wants to stimulate the economy, its usual tool is an open-market purchase of government debt. By increasing the stock of high-powered money, the open-market purchase drives down nominal and real interest rates, and so increases consumption and investment.

Nominal interest rates, however, cannot be negative: since high-powered money has a nominal return of zero (that is, since the nominal value of a dollar next year will be a dollar), investors will never hold bonds with negative yields. Thus when the nominal interest rate on government debt reaches zero, one critical channel through which monetary policy can stimulate the economy is no longer present. Moreover, when the nominal interest rate is zero, government debt and high-powered money are perfect substitutes: both are non-interest-bearing assets issued by the government. In this situation, an open-market purchase is just an exchange of two assets that are perfect substitutes. Thus, there is reason to fear it will have no effects.

Until recently, the possibility of an economy finding itself in such a "liquidity trap" seemed to be only a historical and theoretical curiosity. Two developments, however, changed that perception. First, in Japan, short-term nominal...