The Return of Monetarism

TILBURG, THE NETHERLANDS – The current economic crisis highlights the need for major changes at central banks. It is time for a return to some form of moderate monetarism – but in a twenty-first-century mold.

The current crisis has clearly made central bankers’ jobs far more complicated. Over the last 30 years or so, many central bankers supposed that all they needed to do was keep their sights fixed on price stability. Every instrument they had at their disposal was to be used for that goal. From now on, however, central bankers will have to aim for financial stability as well.

Implicitly, central banks will also have to try to ensure that a new recession does not occur. But the current institutional set-up of today’s central banks is highly inadequate to meeting these challenges. Central banks will have to get additional tools for their new tasks. And that is where things get very complicated.

The reason is simple: according to Tinbergen’s Rule – named for the Nobel laureate Dutch economist Jan Tinbergen – central banks must have one independent instrument for each task they perform, such as ensuring price stability. If they have more than one task, they will need an equal number of instruments.