Teaching Current Monetary Policy

Most of the ingredients of the standard intro econ class have been pretty stable for a long time: opportunity cost and budget constraints, supply and demand, perfect and imperfect competition, externalities and public goods, unemployment and inflation, growth and business cycles, benefits, and costs of international trade. In contrast, the topic of how the central bank conducts monetary policy has shifted substantially more than a decade ago, in a way that makes earlier textbooks literally obsolete. Jane Ihrig and Scott Wolla offer an overview of the changes in "Monetary Policy Had Changed, Has Your Instruction?" (Teaching Resources for Economics at Community Colleges Newsletter, March 2021). For a more in-depth discussion, Ihrig and Wolla wrote: “Let’s close the gap: Revising teaching materials to reflect how the Federal Reserve implements monetary policy” (October 2020, Federal Reserve Finance and Economics Discussion Series 2020-092)

(The TRECC Newsletter has financial support from the NSF and other sources. It currently has about 1500 subscribers. If you are involved in community college teaching, or you teach a substantial number of lower-level undergraduate courses, you may want to put yourself on the subscription list.)

As Ihrig and Wolla point out, the traditional pedagogy of how monetary policy works focuses on how the Federal Reserve can raise or lower a specific targeted interest rate: the "federal funds" rate. It goes like this: 

One big change is in the "policy implementation" arrow. When I was taking intro econ in the late 1970s or when I was teaching big classes in the late 1980s and into the 1990s, the textbooks all discussed three tools for conducting monetary policy: open market operations, changing the reserve requirement, or changing the discount rate. 

Somewhat disconcertingly, when my son took AP economics in high school last year, he was still learning this lesson--even though it does not describe what the Fed has actually been doing for more than a decade since the Great Recession. Perhaps even more disconcertingly, when Ihrig and Wolla looked at the latest revision of some prominent intro econ textbooks with publication dates 2021, like the widely used texts by Mankiw and by McConnell, Brue, and Flynn, and found that they are still emphasizing open market operations as the main tool of Fed monetary policy. 

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