Why we need to know the history of monetary policy
In his speech at the 2017 Asia Economic Policy Conference on November 16, 2017, John Williams, president and CEO of the Federal Reserve Bank of San Francisco, spoke about the history of monetary policy. Then he offered some possible future solutions. It’s important that we understand how we arrived at the current state of monetary policy where central banks target a certain rate of inflation (TIP) and a level of unemployment in their respective economies. Williams gave a brief history of monetary policy in just seven sentences.
History of monetary policy
The concept of monetary policy began in the late 19th century when countries were valued based on the amount of gold (GLD) in their countries. That was referred to as the gold standard. That system was in place until 1944 when the Bretton Woods system came into play, which was partly based on the amount of gold reserves and the price of gold (IAU). Williams said that after the Vietnam War, inflation (GTIP) in the United States skyrocketed, and the US government had to move away from that system. The Bretton Woods system collapsed in the early 1970s, and the current system of free float currencies (UUP) came into effect. Williams said the process of inflation (VTIP) targeting was first introduced in 1989 in New Zealand where they have stated the objective of their monetary policy is to target a certain level of inflation to keep the economy growing at a steady pace.
Why is inflation so important?
In any economy, the cost of goods is the primary driver of demand and supply. When prices are expected to rise, consumers start purchasing goods to avoid paying a higher price later. That increases the demand for goods, and a higher demand increases prices. The demand prompts manufacturers to increase production, which could lead to a higher level of demand for labor and finally higher wages. This cycle has its ups and downs, and when demand starts falling, economies can go into a recession. The central banks target inflation by increasing or decreasing interest rates, which is the current system followed by central banks around the world.
In the next part of this series, we’ll analyze how low interest rates are limiting the central bank’s potential to combat future recessions.