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Monetary Stimulus Can’t Boost Long-Run Growth But Can Trim It

Stimulative monetary policy can’t increase real economic growth in the long run -- but can reduce it.

In a recent Economic Commentary, Federal Reserve Bank of Cleveland Economic Advisor Owen F. Humpage says that central bank actions to stimulate money supply growth can increase overall spending. That rise in spending may boost real economic growth in the short term, but only when the public fails to anticipate the policy change and misinterprets the accompanying price increases. According to Humpage, frequent attempts to exploit such possibilities will eventually be noticed and could actually backfire.

In most of the largest industrialized nations, faster money growth seems to precede faster economic growth by one year. But faster rates of money growth are not correlated with higher rates of long-term real economic growth. In fact, attempting to promote economic prosperity through expansionary monetary policies could have a detrimental effect on long-term economic growth.

Humpage explains that money contributes to economic efficiency by reducing the transaction costs associated with economic exchange. He notes that the ability of money to reduce those costs depends on its general acceptance. If people question the stability of a monetary asset’s purchasing power, transaction costs will rise. Moreover, as inflation accelerates, households and businesses will spend more time, energy, and resources protecting their financial wealth from inflation. Fewer resources will go into capital accumulation or productivity-enhancing innovations. Indeed, some studies have found that a 10-percentage-point increase in the long-run average inflation rate is associated with declines of 0.2 to 0.7 percentage point in long-term economic growth.

Humpage concludes that a central bank can best contribute to a nation’s economic health by eliminating the price uncertainties associated with inflation.

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