Monetary Policy and Central Banking after the Crisis: The Implications of Rethinking Macroeconomic Theory

The financial crisis and Great Recession have prompted a rethink of monetary policy and central banking. The status quo insider rethink focuses on the role of monetary policy in dealing with asset bubbles; making the central bank the banking system supervisor; and how to deal with the problem of the zero lower bound to nominal interest rates. This paper presents an outsider reform program that focuses on central bank governance and independence; reshaping the economic philosophy of central banks to be more intellectually open-minded; major monetary policy reform that includes adoption of an inflation target equal to the minimum unemployment rate of inflation (MURI) and implementation of asset based reserve requirements; and regulatory reform that addresses problems of flawed incentives, excessive leverage, and maturity mismatch.The proposed outsider reform program is rooted in a rethink of macroeconomic theory compelled by the crisis. There are some overlaps between the insider and outsider reform programs but they are more form than substance. That is dangerous because it can confuse debate if similarity of form is mistaken for similarity of substance.The insider program makes no changes to macroeconomic theory and is uncritical of the Federal Reserve's past actions. From its perspective, any failings of the Federal Reserve have been unwitting sins of omission. The outsider program fundamentally challenges existing macroeconomic theory and is also highly critical of the Federal Reserve. From its perspective the failings of the Federal Reserve have included significant sins of commission rooted in political capture, cognitive capture and intellectual hubris.The outsider critique can be taken even further. The Federal Reserve is already legally mandated to pursue maximum employment with price stability. However, it needs institutional transformation that makes it think of itself as an agent for helping realize the "American Dream". That means it should have a duty to shape the allocation of credit and the financial system in ways that ensure growth, full employment and a fair shake for all.