Friday, June 24, 2011

Wealth and Income Effects of Monetary Policy

Back when I worked for the Federal Reserve Bank of Chicago, there were a couple of issues that had to be dealt with repeatedly. One was the limitations of monetary policy – there were certain macroeconomic goals that were easier than others to address through monetary policy. The other was the fact that monetary policy was a broad tool.  One could not really initiate policy to affect a narrow sector of the economy – too often it had effects on other areas.

This latter is illustrated well in an opinion piece (free content at time of this writing) from today’s edition of The Wall Street Journal . The piece is critical of the Fed’s monetary policy move referred to as QE2.  The charge is that it was meant to have a specific effect on financial markets, but has had unintended consequences in other markets, such as commodities.  While I don’t pretend to know whether this is true or not, the piece does explain how QE2 resulted in wealth effects and income effects.  And it is there that it provides a service for those of us who teach.

In explaining the linkage between an accommodative monetary policy and prices (of both securities and commodities) it can be used to help students understand the wealth effects (confidence arising from rising stock prices) and income effects (falling real income) that accompany the changing value of the dollar.

You might want to take a look. Let me know if you agree.

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