Unanticipated Money Growth

A large part of life is expectations: managing them, dealing with them, having them...or not. This is what American macroeconomist Robert J. Barro, prof at Harvard, really wanted people to know in the late 1970s and beyond.

Barro put forth the idea that measuring the effect of “money growth” on the economy as a factor on its own...is a mistake. Money growth means the expansion of the money supply, where the central bank pumps more dollar bills into the system, oftentimes in the form of buying bonds from banks, giving them a cash infusion. Barro argued that, if everyone anticipated money growth, prices would go up accordingly in a one-to-one ratio. In other words: pumping more money into the economy when everyone expects it just leads to inflation, and not much else. Bummer.

Unanticipated money growth, on the other hand, is another story. When nobody knows it’s coming, businesses don’t raise prices in anticipation of the expansion of the money supply. Sure, they’ll notice eventually, but this effect will be lagged. That gives the economy a chance to actually use that infusion of money before it disappears into inflation.

That’s a big deal, because it can affect things like unemployment and GDP. Of course, a lot of other factors affect unemployment and GDP, but still. Barro’s got a point, with empirical data to back up his theories.

To Barro, context is key. Whether or not people know about impending monetary policy will greatly determine the actual effect of that monetary policy. Once-Fed-Chair Al Greenspan was famous for “Greenspeak," which is where he would ramble and not really answer questions about his monetary policy plans. Al wasn’t cray. He did this on purpose, because he didn’t want everyone anticipating his movements, which might render his movements useless.

Notably, Fed Chairs since haven’t been Greenspeaking. For the most part, they announce what’s happening. But who knows...maybe that’s a part of their plan, too: making people behave a certain way by merely announcing something, even before that something is actually implemented...like changes in interest rates.