22 - Peter Ireland on the Chicago School, Federal Reserve Policy Targets, and Monetary Aggregates

Episode Summary

Executive Summary: Peter Ireland traces his macroeconomics background to Chicago’s Friedman-Lucas tradition and argues that monetary policy is best understood through instruments, intermediate indicators, and goals. He defends interest-rate targeting as operationally sensible but warns against over-smoothing all asset prices, and makes the case that well-measured monetary aggregates—especially Divisia measures—still matter for forecasting nominal income and guiding policy.

Main Topics: Chicago School influences and training in macroeconomics (Priority: 5/5): Ireland explains how Friedman’s influence, Chicago price theory, and exposure to Cochran, Lucas, and Woodford shaped his move from applied micro interest to rigorous dynamic macro and monetary economics. Monetary policy framework: instruments, targets, and goals (Priority: 5/5): He distinguishes between the policy instrument (short-term interest rates or reserves), intermediate indicators (money growth, forecasts), and ultimate goals (inflation and employment/nominal income), emphasizing why those distinctions matter. Interest-rate targeting vs. monetary base control (Priority: 4/5): Ireland argues the Fed can operationally target the federal funds rate by adjusting reserves, but notes an alternative regime could target reserves or the monetary base with short-term rate volatility largely inconsequential if expectations are stable. Taylor rule and modern policy practice (Priority: 5/5): He places the Taylor rule as a practical guide that uses inflation and the output gap to set rates, and notes that it can be adapted to nominal GDP-style stabilization; it replaced money-growth rules largely because central banks shifted to interest-rate operating procedures. Money still matters: simple sum vs. Divisia aggregates (Priority: 5/5): Ireland criticizes simple-sum monetary aggregates for ignoring differing liquidity services and endorses Divisia measures, which use price-theoretic weights derived from interest-rate differentials to better measure monetary services. Nominal GDP targeting and the money gap (Priority: 4/5): Drawing on his paper with Mike Belongia, he explains how Divisia money and a time-varying velocity adjustment can restore money’s predictive power for nominal income and help construct an M-star/money-gap indicator for policy. Why nominal income growth slowed after the Great Recession (Priority: 4/5): Ireland attributes weaker post-crisis nominal income growth partly to slower real growth, but also to persistently low inflation, which he sees as evidence of insufficiently accommodative monetary policy.

Key Arguments: Monetary policy is best analyzed by separating the policy instrument, intermediate indicators, and ultimate goals because policy actions affect the economy with long and variable lags. The Fed’s real operational instrument is the short-term nominal interest rate, but it can control that rate only because it supplies reserves as the monopoly issuer of reserves and currency. Targeting interest rates helps stabilize high-frequency money-market volatility, but policymakers should not try to suppress all interest-rate or asset-price movements because prices convey information. The Taylor rule is a practical rule-of-thumb for setting the funds rate based on inflation and the output gap, and variants can be used to stabilize nominal GDP. Simple-sum monetary aggregates are conceptually flawed because they add assets with different liquidity services as if they were identical. Divisia aggregates are superior because they weight monetary assets by the liquidity services implied by interest-rate differentials, making them more consistent with economic aggregation theory. Empirical claims that money ceased to matter were often based on simple-sum aggregates; when studies are redone with Divisia money, predictive content for nominal income often returns. A nominal-income-targeting framework can be operationalized in real time using Divisia money and an M-star/money-gap concept that accounts for slow-moving changes in velocity. Post-Great-Recession weakness in nominal income reflects both slower real growth and chronically low inflation, suggesting monetary policy remained too tight relative to the economy’s needs.

Data Points: Monetary policy conference date: September 7th - Opening promotion for the Mercatus/Cato conference 'Monetary Rules for a Post-Crisis World'. Chicago PhD years: 1984 to early 1990s - Ireland describes his University of Chicago training period. Conference panelists mentioned: John Taylor, Miles Kimball, Scott Sumner - Listed as examples of speakers at the upcoming monetary policy conference. Federal Reserve policy objective: 2% inflation target - Ireland references the Fed’s inflation goal when discussing the Taylor rule and current policy. Inflation shortfall: about 25 basis points below target - Current environment discussion under the Taylor-rule framework. Funds rate movement example: 100 basis points - Used to illustrate how market reaction differs across regimes versus within a regime. Years of post-crisis slowdown: post-2008 period - Ireland refers to the Great Recession and the sluggish recovery that followed. Financial crisis period: 2007-2008 - Discussing the bank run and stress in institutional money markets.

Pivotal Quotes: "the spirit of Friedman was still very much alive in the 1980s" — Peter Ireland: On the intellectual environment at Chicago when he studied there. "you cannot just add them up and say in both cases that GDP is three" — Peter Ireland: Explaining why simple-sum monetary aggregates are flawed by analogy to adding unlike goods. "if the Federal Reserve tried actively to stabilize inflation, more often than not, it would be moving in the wrong direction destabilizing instead of stabilizing" — Peter Ireland: On the limits of reacting directly to noisy inflation data instead of using a monetary intermediate target.

Implications: Listeners should take away that money did not become irrelevant; measurement improved. For policymakers, Divisia aggregates and money-gap analysis may still offer useful real-time guidance, especially when inflation is persistently below target and nominal income is weak.