As interest rates approach zero, and central banks look at "unorthodox" monetary policies, the Neo-Wicksellian perspective on monetary policy has switched to a blank screen. We are witnessing the return of Monetarism.
That's the main reason why economists find it hard to think about unorthodox monetary policies. The dominant Neo-Wicksellian paradigm which fills our heads can say nothing about them. We are forced to return to older, half-forgotten ways of thinking. There is perhaps a "Dark Age" in thinking about monetary policy, just as much as in thinking about fiscal policy.
The dominant paradigm for monetary policy over the last decade has been the Neo-Wicksellian perspective: monetary policy is the central bank setting a short-term nominal rate of interest. The current short-term rate of interest, and expected future short-term rates of interest (solved for in a model-consistent or "rational" way), determine current demand for output (on an IS curve). Demand for output is assumed to determine current actual output, since firms are monopolistically competitive. Current output, plus expected future inflation (again solved for in a model-consistent way), determines inflation via a Phillips Curve equation.
In short, the canonical Neo-Wicksellian model is an ISLM model (plus a BP curve for an open economy), plus a Phillips curve, plus rational expectations, plus as much microfoundations as the New-Keynesian modellers can handle. Except: the LM curve is not really an LM curve; it's a monetary policy reaction function, in which the central bank sets the interest rate as a function of various indicators. It's certainly a model of a monetary exchange economy (as opposed to barter), but money itself appears nowhere in the model.
You can always add money to the model, if you like, by adding a money demand function. But it doesn't do anything. The quantity of money would be demand-determined, by whatever amount people want to hold at the rates of interest, prices, and incomes determined by the rest of the model. Money is a fifth wheel: an epiphenomenon. You could delete it from the model without anything else changing.
The standard model of monetary policy, in other words, says absolutely nothing about money. 'M' does not appear in the model. As David Laidler wrote, it's like "Hamlet without the ghost". "Quantitative easing" cannot be understood using a model where M, the quantity of money, does not appear.
And when I talk about "the standard model of monetary policy" I mean both the computer models that central banks use in setting monetary policy, and the models in the heads of monetary economists when they teach or research monetary policy. The canonical Neo-Wicksellian graduate textbook, Michael Woodford's "Interest and Prices", is a model of a cashless economy. Our heads can't handle quantitative easing, because the quantity in question is no longer in our heads.
The only way of thinking about unorthodox monetary policies, in the dominant Neo-Wicsellian paradigm, is in terms of the central bank creating expected inflation. This would reduce real interest rates (with nominal rates stuck at zero), and would increase consumption and investment demand. But this is useless advice, because there is no actual mechanism whereby the central bank can create expected inflation. It can only push on the useless lever of interest rates, which is already stuck at zero.
So we need to revert to an older, earlier way of thinking. Monetary policy is about changing the stock of money. The objective of monetary policy, in a recession, is to create an excess supply of money. People accept money in exchange for whatever they sell to the central bank, because money by definition is a medium of exchange. But they don't want to hold all that money. Or rather, the objective of the central bank is to buy so much stuff that people don't want to hold the money they temporarily accept in exchange. An excess supply of money is a hot potato, passing from hand to hand. It does not disappear when it is spent. It spills over into other markets, creating an excess demand for goods and assets in those other markets, increasing quantities and prices in those other markets. And it goes on increasing quantities and prices until quantities and prices increase enough that people do want to hold the extra stock of money.
That's classic Monetarism. That's what I learned from David Laidler. That's what I hear when I read Scott Sumner too.
I will return to this theme. But right now I need to do a little university administration for Carleton.