Throughout the last decades, the nominal interest rate became the dominant monetary policy instrument. Looking backward, the early 1980s proved to be a transition period in terms of monetary policy. After the monetarist experiences of Thatcher and Reagan, there was a pragmatic shift from the supply of the monetary base to the interest rate as monetary policy instrument. The recognition that the control of the monetary base could not only impose extreme volatility to the interest rate but also deeply affect the whole economy challenged, in fact, the previously stable empirical relationship between money supply, demand for money, prices, and income supported by Milton Friedman.
At the theoretical level, the so-called “New Consensus in Macroeconomics” favoured the short-term interest rate as the policy instrument in conjunction with inflation targeting. The new-Keynesian so-called “Taylor rule” has increasingly turned out to be adopted by central banks to manage the interest rate as the policy instrument. In this policy approach, the central bank, mainly through open market operations, sets the short-term interest rate in order to adjust its level in response to changes in inflation and output. In a framework of capital account openness, however, the autonomy of monetary policy, aimed to stabilize prices, subordinates the fiscal budget.
After the global financial crisis, academic economists and policy makers have actively participated in the debate on monetary policy. After the bail-outs, central banks in the US and European Union focused on lender-of-last-resort program extensions and dealt with multiple challenges: how to prevent a recessionary downturn, how to avoid asset and credit bubbles and inflationary pressures. The unprecedented actions of the Federal Reserve, European Central Bank and the Bank of England, for example, suggest the need to rethink the traditional scope of the lender of last resort. The scope of the recent central banks’ interventions has been expanded in order to include not only the provision of liquidity as lender of last resort, but also to include the expansion of repurchase agreements as buyer of last resort and the supply of liquidity to specific markets as market maker of last resort.
The modern Keynesian literature emphasizes that, even if increasing the current money supply has no effect, monetary policy is far from ineffective at zero interest rates. What is important, however, is not the current money supply but managing expectations about the future nominal and real interest rates. Thus, recent research indicates that monetary policy is far from being ineffective at zero bound levels, but it worked mainly through expectations. So far, the key-issue is how very low or negative interest rates translate into improved growth rates since austerity programs are biased towards entrenching mass unemployment and introducing anti-social structural reforms.
The debate about the appropriate policies to achieve economic growth has been recently fuelled by the advocates of the MMT (Modern Monetary Theory). According to Warren Mosler, for instance, the mainstream version of fiscal responsibility is based on false premises. In his view, MMT provides new guidelines for the fiscal position for governments since the role of fiscal policy is to ensure there is no spending gap. Fiscal interventions, through direct government spending and/or a tax cut to increase private disposable income, aim to create demand and provide enough jobs for all the workers who desire to work. Therefore, a zero spending gap occurs when the level of national income is a full employment
Against the Non-Accelerating Inflation Rate of Unemployment (NAIRU) that refers to the concept of full employment irrespective of how many workers are unemployed or underemployed, the MMT advocates propose the NAIBER – the Non-Accelerating Inflation Buffer Employment Ratio. The concept of NAIBER, designed by the economists Bill Mitchell and Warren Mosler, is associated to the idea of a Job Guarantee programme managed by the government in order to hire unemployed workers as an employer of last resort (ELR). Beyond negative rates and quantitative easing, MMT specifies a new discipline for the fiscal policy: if the goal is full employment and price stability, then the full-employment fiscal deficit condition has to be met.
Although the idea of ELR is not new, the current debate on price stability considers the creation of jobs at the center of policy making. Against mainstream economics, it is urgent to develop alternatives to face the social challenges of unemployment, underemployment, informality and poverty at large scale.