The "Discipline and Punish" View of Interest Rates

Moneybox
A blog about business and economics.
Aug. 1 2012 4:24 PM

The "Discipline and Punish" View of Interest Rates

Here's Philipp Rösler, Vice-Chancellor of Germany and Economy Minister, offering the clearest account yet of how European monetary policy has gone so far off the rails:

“If you take away the interest rate pressure on individual states, you also take away the pressure for them to reform.”
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The view here is that because countries ought to pursue good pro-growth structural policies, central banks ought to create unfavorable monetary conditions as a way of pressuring countries to pursue structural reforms.

There are many problems with this approach, but perhaps the most basic is that it will mix up the signal and noise in the policy dynamic. If monetary policy tries at all times to deliver appropriate monetary conditions, then we know that structural reforms are either working or failing because the situation will either improve or not. But if the central bank makes its delivery of appropriate monetary conditions contingent on legislatures adopting sound structural policies, then all we really know about structural reforms is whether or not they're the ones the central bank happens to think will work. You're eliminating the real-world test and substituting the bank staff's judgment.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.