Three Essays on Monetary Economics and Policy

Patrick Horan

Advisor: Carlos D Ramirez, PhD, Department of Economics

Committee Members: Lawrence White, Garett Jones

Buchanan Hall, #D180
November 08, 2023, 02:45 PM to 04:45 PM


This dissertation consists of three chapters on monetary economics and policy. The first two chapters deal specifically with U.S. monetary issues. The third chapter traces Milton Friedman’s thinking on monetary theory and policy, more generally, but it is also relevant for U.S. monetary policy considerations.

Chapter 1, coauthored with David Beckworth, examines the flexible average inflation targeting (FAIT) framework adopted by the Federal Reserve in 2020 and the framework’s failure to prevent the current inflation surge. This failure is the result of challenges created by FAIT’s asymmetric design. We argue that applying symmetric makeup policy and treatment of supply shocks can improve the FAIT framework in achieving the Federal Reserve’s stated goal of achieving 2 percent average inflation. Doing so would give FAIT the properties of a nominal GDP-level target, so we call this proposed framework FAIT-N. We show how to operationalize this framework using a measure called the NGDP gap. This chapter was previously published as a Mercatus Center working paper.

Chapter 2 assesses the performance of Divisia and simple-sum monetary aggregates in explaining changes in key macroeconomic variables in the United States from 1967 to 2022. In the spirit of Friedman and Schwartz, I extract the cyclical components of money, output, and prices, and find that money generally leads the latter two variables. Next, I test for Granger causality from monetary aggregates to several measures of real activity. Then, I estimate a more inclusive VAR consisting of multiple real and nominal variables. Consistent with theory and previous research, Divisia aggregates outperform their simple-sum counterparts. While the narrower aggregates exhibit a close relationship with output and prices in the earlier years of the sample, the broader aggregates outperform the narrow aggregates over the entire period. This reflects an evolution of the monetary system where assets included in the broad aggregates became increasingly important. Finally, I use counterfactual forecasts to find that broad Divisia money played an important role in explaining the severity of the Great Recession and the high inflation of 2021 and 2022.

Chapter 3 considers Milton Friedman’s normative views on monetary policy. For much of his career, Friedman advocated a constant money growth rule to limit central bank discretion and to achieve long-term price stability. By contrast, he wrote little on nominal income stabilization as an alternative goal for monetary policy. Despite this, a careful examination of Friedman’s work shows that the desirability of a constant money growth rule in his view depended on its ability to stabilize nominal income. Given Friedman’s preference for simple rules, requiring minimal knowledge on the part of central banks, he would have had strong reason to support nominal income targeting over central banks’ standard practice of inflation targeting. I consider several strategies for achieving a nominal income target, including a modified Taylor rule and multiple monetary base rules.