SOAS Research Online

Abstract

Monetary authorities have the advantage over the private sector because of the longevity of their institutions and their exclusive power to issue fiat money. These defining features of central banking have, however, been overlooked by much of the recent literature on the effects of monetary policy. Counter-cyclical demand management policies can thus be effective even when the government is at an informational disadvantage vis-à-vis the private sector. In a dynamic setting with overlapping generations, monetary policy can also influence capital accumulation in the long run. The key for these results is that, with incomplete private markets, the government has a richer opportunity set than the private sector thanks to its ability to implement contingent forward contracts. Access to a wider opportunity set and a longer intertemporal horizon are crucial for the conduct of monetary policy during a crisis, such as the responses to the 2008 financial crisis and to the current COVID-19 pandemic.