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Economists have to change

The way we think about monetary policy, economy and wealth has changed with the adoption of quantitative easing (QE): It has moved from being a one-dimensional problem of only setting the policy rate (PR) to a two-dimensional problem of jointly determining the PR and QE. Therefore also the way Economists are educated and trained has to change. The whole Economic thinking should be reset. Most of the rich world is enjoying a jobs boom even as central banks undershoot inflation targets. America’s jobless rate, at 3.5%, is the lowest since 1969, but inflation is only 1.4%. Interest rates are so low that central banks have little room to cut should recession strike. Even now some are still trying to support demand with quantitative easing (qe), ie, buying bonds. This strange state of affairs once looked temporary, but it has become the new normal. As a result the rules of economic policy need redrafting—and, in particular, the division of labour between central banks and governments. That process is already fraught. It could yet become dangerous.

Money is not the only driver anymore

The central bank policy rate is used by central bank to implement or signal its monetary policy stance. It is most commonly set by the central banks policy making committees. "This new reality requires a framework by the central bank to derive the optimal combination of these two variables given a desired monetary policy stance needed to achieve its policy objective," says S&P Global Chief Economist Paul Gruenwald. "Moving to a two-dimensional world for monetary policy raises a host of issues, including the policy rate space away from zero, the use of dot plots, which represent PR only, to communicate future policy intent, and the predictive power of the yield curve." And as we continue to exit the long shadow of the global financial crisis, questions remain about unconventional monetary policies. This will affect the U.S. Federal Reserve first, with other major central banks (eventually) following. Specifically, what will the terminal balance sheet look like? Will central banks go back to using the PR as the only tool with no QE and no excess bank reserves? Or will QE--and larger balance sheets--be a permanent fixture of the landscape? How will central banks make that decision? And how Economists have to change their focus?

Economist have to serve society much more

Economics is a social science concerned with the analysis of the production, distribution, and consumption of goods and services. It's the application of mathematics to the study of social behaviors in a large number of settings. Economists tell society about itself, but they have to become more visionary than they have been up to now to serve society in the right way. Economics is often confused with Finance. This is not without good reason: money is the medium of economic exchange: and the two are extremely dependent upon each other. But economists do not control the economy any more than physicists control the laws of physics. While their models are sometimes quite vague, this is intentional - vague statements should always be indicative of uncertainty. Indeed, Economists will throw out a model without a stochastic (random) error term. Any economist who makes an assertion of fact in their forecasts either hasn't been around long enough, or is saying something painfully obvious. So a social role for economists? Using the anthropological definition of the term, they should find answers to the unanswerable.

The role of Central banks has to change

The Fed's precrisis balance sheet had liabilities consisting of cash in circulation and a small amount of bank reserves needed for the smooth functioning of the interbank market. There were no excess reserves. The central bank supplied only the amount of reserves necessary to achieve its target federal funds rate, which was the sole instrument used by the central bank achieve its policy objectives. The size of the balance sheet was around $900 billion. The Fed's maximum post-crisis balance-sheet size reached about $4.5 trillion. How did this quintupling of the balance sheet happen? After hitting the zero bound for its policy rate in late 2008, and still needing to ease its monetary stance further to achieve its policy objectives, the Fed began to purchase high-quality assets from the market (Treasuries and mortgaged-backed securities). This policy of quantitative easing continued for several rounds, ultimately generating around $2.5 trillion of excess reserves in the banking system.
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