Commentary

Abstract

In his article, Alex Cukierman has undertaken the difficult task of rationalizing the observation made by many that a goal or an intermediate objective of monetary policy in the United States is to smooth fluctuations in interest rates. In a setting where banks serve to transform short-term liabilities into long-term loans for their customers, he argues that if the Fed is concerned about both the stability of the banking system and price stability, then optimal monetary policy involves reducing the variance of interest rates. Although other economists have suggested that an objective of financial stability motivates a policy of smoothing interest rates—for example, Good-friend (1987)—Cukierman formalizes this idea by studying a choice-theoretic model of monetary policy in which the banking system is specified on the basis of micro-principles.¹ In equilibrium, by trading off the costs of financial instability against those of inflation, the Fed dampens short-term movements in interest rates. The equilibrium tradeoff, however, involves what Cukierman calls an“inflationary bias.” Without going into much of the technical detail of his analysis, my comments on his positive theory focus on his modeling strategy and his choice of an equilibrium.