Arnold Kling posts the following:
1. Policy has no effect. Markets do what they will do, regardless. The market uses the best prediction model, so economists’ macro models can, at best, replicate the market’s implicit model.
2. Policy has an effect, but markets try to anticipate policy. The expected component of policy has no effect. Only policy surprises have an effect.
It seems to me that the market monetarists (e.g., Scott Sumner) believe something closer to (2) than to (1). But (2) can get you into some strange conundrums. Does the Fed have free will? That is, does it have the ability to surprise markets, other than by acting randomly? If its actions are not random, they should be anticipated by markets. If they are anticipated by markets, then they should have no effect. etc.But what is the conundrum? He could just as truly be writing about Congress. Congress can write legislation that effects the market. Congress can effect long-term growth, price to dividend, and interest rates. Does Congress have free will? Does it act randomly?
The same "conundrum" surrounds firms. Only unexpected news about firms moves markets. Does that mean Bill Gates can have no effect on the price of Microsoft's stock? Could he wake up tomorrow and deliberately tank it? In fact, markets are always trying to anticipate what CEOs are doing and evaluate how their actions will change the value of the underlying stock.
So where is the conundrum? Why does thinking about the Fed this way make Kling so uncomfortable?
HT: Scott Sumner (with his own comments)