With great power comes great responsibility

Romer and Romer think monetary policy could do more if only central bankers believed in themselves. Scott Sumner might agree these days.

Our thesis in this paper is that overly pessimistic views about the power of monetary policy have been a more important source of these errors than have overly optimistic views. There is little doubt that an overinflated belief in the power of monetary policy has contributed to some major policy errors. Most famously, policymakers in the mid-1960s believed that they faced an exploitable long-run inflation-unemployment tradeoff, and thus that monetary policy could move the economy to a sustained path of low unemployment and low inflation. This belief led them to pursue highly expansionary policy, starting the economy down the path to the inflation of the 1970s. The record of such errors has led many to argue that perhaps the most important attribute of a successful central banker is humility.

In this paper, we present evidence that the opposite belief—an unduly pessimistic view of what monetary policy can accomplish—has been a more important source of policy errors and poor outcomes over the history of the Federal Reserve. At various times in the 1930s, faced with the Great Depression, Federal Reserve officials believed that the power of monetary policy to combat the downturn or stimulate recovery was minimal. In both the midand late 1970s, faced with high inflation, policymakers believed that monetary policy could not reduce inflation at any reasonable cost. And there is evidence that in the past few years, faced with high unemployment and a weak recovery, monetary policymakers believed that policy was relatively weak and potentially costly. In each episode, the belief that monetary policy was ineffective led to a marked passivity in policymaking.

Matt Yglesias comments.