Changing Effects of Monetary Policy

A series of developments in the U.S. economic environment in the 1980s has resulted in major changes in prevalent thinking about how monetary policy affects economic activity. One important part of this change simply reflects the heightened awareness, following the experience of disinflation early in the decade, that monetary policy is not neutral-that is,,that actions taken by h e central bank can and do influence real economic outcomes. Indeed, in the wake of the early 1980s disinflation, the more traditional view that monetary policy affects inflation by and only by influencing real economic activity seems much closer to the mark than the polar opposite view, which became increasingly popular in the 1970s, that monetary policy determines prices without affecting real economic activity at all. Another aspect of the change in thinking about monetary policy that has taken place in recent years reflects the loss of confidence in the conventional monetary aggregates as a satisfactory measure of the effect of monetary policy on either real economic activity or prices. Standard relationships between the M's and either real or nominal income have largely broken down, and the correlation between money growth and price inflation, calculated in the way advocated by Milton Friedman (that is, using two-year moving