16 April 2014

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The Centre for Monetary Advancement (CMA) seeks to develop new methods of structuring national monetary systems in the pursuit of economic stability and sustainable long term growth through equitable and efficient institutional arrangements.

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A More Effective Monetary Policy Approach

Daniel Kruppa, 14 November 2013


At present the major central banks conduct monetary policy primarily through interest rate targeting and quantitative easing. Altering the cost or quantity of money or purchasing assets from the marketplace can potentially affect spending and lending levels primarily through expectations, the interest rate channel and net wealth of agents through portfolio rebalancing (Bank of England 2011). During times of monetary stimulus lower interest rates stimulate lending while asset holders through the wealth effect  will become more accesible to credit and increase their spending, but becuase the distribution of assets is very uneven and debt to GDP levels are at or near all time highs the effect on expectations, consumption and lending is significantly reduced.

A more effective transmision mechanism for monetary policy needs to be established where the wealth effect is experienced in a broad and balanced manner amongst a greater set of economic agents with a higher marginal propensity to consume. This can be achieved if the central bank directly interacts with the broad public by increasing money balances while monitoring its economic goals. A mechanism whereby the central bank can conduct helicopter drops with people without relying on the cooperation of government in order to maintain central bank independance should require legislative action to come into effect.

Limitations of interest rate targeting and quantitative easing

When the central bank purchases assets or lowers the interest rate on reserves a portfolio rebalancing effect into other asset classes should occur. Higher demand for riskier assets should increase their prices and reduce market interest rates which in turn should increase lending and spending as a result of greater net wealth of asset holders. The effectiveness of portfolio rebalancing in affecting employment, inflation and gdp through the wealth effect and the credit channel is dependant on how widely held assets are and agents willingness to borrow.

Inequality of asset holdings reduces the effectiveness of reserve targeting and asset purchases. If assets arent widely held most of the wealth effect will be experienced by  wealthier agents which have a low MPC and not much of a wealth effect will be experienced by less wealthy agents with a high MPC. Therefore the effect on spending will be limited due to a low average MPC which will result in a low velocity of money. This can be observed in the US where over 90% of stocks are owned by the wealthiest 20% while the bottom 60% own approximately 2.5% of stocks (Wolff, 2012). Approximately 65% homeownership rate leaves approximately one third of households not experiencing the wealth effect of house price increases (US Census Bureau).

As a result of quantitative easing and lower interest rates on reserves market  interest rates have declined but lending has not significantly increased largely because debt to GDP levels are near historical highs and people wish to deleverage or stabilise their debt levels in order to improve their balance sheets.  This can be observed in the US where the poorest 40% have negative net wealth (Wolff, 2012).

Monetary policy has not been effective at improving the economy through the expectations channel either. Future income expectations in the US remain suppressed since the most recent recesion. 


In order to increase the effectiveness of MP a more efficient transmision mechanisms need to be enacted whereby the wealth effect will be experienced by a greater number of economic agents with a higher MPC which will have a greater effect on spending while improving accesibility to credit through balance sheet improvements.

A more efficient monetary policy mechanism

In order to more acurately attain its goals the central bank should bring into effect a mechanism which allows it to directly interact with a wider and more balanced spectrum of the economy not just banks...

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