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Rewriting Textbook Economics

The Fed's decision to sustain quantitative easing for at least another month is the latest reflection of a fundamental shift in central banks' approach to monetary policy. What was once standard has become almost unthinkable, and the exceptional – near-zero interest rates and large-scale asset purchases – has become the norm.

TILBURG – Federal Reserve Chairman Ben Bernanke’s recent announcement that the Fed would maintain the current pace of monetary stimulus in the United States has cinched it: economics textbooks, at least the chapters on monetary policy, need to be rewritten.

After US investment bank Lehman Brothers collapsed in 2008, it did not take long for advanced-country central banks to recognize that conventional monetary policy would be inadequate to contain the fallout of the ensuing crisis. So they bucked accepted theory, as set forth in standard textbooks like Principles of Economics by Greg Mankiw and Money, the Financial System, and the Economy by Glenn Hubbard, in favor of so-called “unconventional” monetary policy.

Five years later, these policies remain intact. This means that today’s undergraduates – and recent graduates – have studied economics during a period of uninterrupted reliance on near-zero interest-rate policies (ZIRP) and large-scale asset purchases, known as quantitative easing (QE). For them, a federal funds rate (the interest rate that banks charge each other for overnight loans of their reserves held at the Fed) of 5% seems as fantastic as a unicorn.