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Since the inflationary 1970s, theoretical work on monetary policy has concentrated almost exclusively on price-level stabilization and the avoidance of nominal shocks. In the aftermath of the collapse of financial bubbles in various parts of the world, the accomplishments and limitations of this dominant approach are debated in this volume edited by Axel Leijonhufvud, with contributions by a number of noted monetary economists, including Nobel Laureate Robert Lucas.
Over the past two decades, many low- and lower-middle income countries (LLMICs) have improved control over fiscal policy, liberalized and deepened financial markets, and stabilized inflation at moderate levels. Monetary policy frameworks that have helped achieve these ends are being challenged by continued financial development and increased exposure to global capital markets. Many policymakers aspire to move beyond the basics of stability to implement monetary policy frameworks that better anchor inflation and promote macroeconomic stability and growth. Many of these LLMICs are thus considering and implementing improvements to their monetary policy frameworks. The recent successes of some LLMICs and the experiences of emerging and advanced economies, both early in their policy modernization process and following the global financial crisis, are valuable in identifying desirable features of such frameworks. This paper draws on those lessons to provide guidance on key elements of effective monetary policy frameworks for LLMICs.
With the collapse of the Bretton Woods system, any pretense of a connection of the world's currencies to any real commodity has been abandoned. Yet since the 1980s, most central banks have abandoned money-growth targets as practical guidelines for monetary policy as well. How then can pure "fiat" currencies be managed so as to create confidence in the stability of national units of account? Interest and Prices seeks to provide theoretical foundations for a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets. In such a world, effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing. Michael Woodford reexamines the foundations of monetary economics, and shows how interest-rate policy can be used to achieve an inflation target in the absence of either commodity backing or control of a monetary aggregate. The book further shows how the tools of modern macroeconomic theory can be used to design an optimal inflation-targeting regime--one that balances stabilization goals with the pursuit of price stability in a way that is grounded in an explicit welfare analysis, and that takes account of the "New Classical" critique of traditional policy evaluation exercises. It thus argues that rule-based policymaking need not mean adherence to a rigid framework unrelated to stabilization objectives for the sake of credibility, while at the same time showing the advantages of rule-based over purely discretionary policymaking.
While there is ample evidence that high inflation is harmful, little is known about how best to reduce inflation or how far it should be reduced. In this volume, sixteen distinguished economists analyze the appropriateness of low inflation as a goal for monetary policy and discuss possible strategies for reducing inflation. Section I discusses the consequences of inflation. These papers analyze inflation's impact on the tax system, labor market flexibility, equilibrium unemployment, and the public's sense of well-being. Section II considers the obstacles facing central bankers in achieving low inflation. These papers study the precision of estimates of equilibrium unemployment, the sources of the high inflation of the 1970s, and the use of non-traditional indicators in policy formation. The papers in section III consider how institutions can be designed to promote successful monetary policy, and the importance of institutions to the performance of policy in the United States, Germany, and other countries. This timely volume should be read by anyone who studies or conducts monetary policy.
This book sets out, in straightforward, accessible terms, crucial aspects of monetary economics. It opens with an exposition of the fundamental question of what money is and what it does. Distinguished contributors then examine the key role of price stability and how to achieve it. Core issues addressed include: an examination of the long run effect of money on prices an analysis of the complex and variable relationship between money and fluctuations in the real economy an investigation of inflation and its dangerous consequences an analysis of the effect of regulation on the stability of financial systems in developed and developing countries the relationship between the money supply regime and economic performance the effect of monetary fluctuations on the interest rate the choice of targets for monetary policy. This book will be extremely useful to practising economists, students and scholars of financial and monetary economics.
At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous debt creation. We study these claims by embedding a comprehensive and carefully calibrated model of the banking system in a DSGE model of the U.S. economy. We find support for all four of Fisher's claims. Furthermore, output gains approach 10 percent, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy.
An overview of recent theoretical and policy-related developments in monetary economics.
Inflation targeting (IT) serves as monetary policy framework in several advanced economies, where it has enhanced policy transparency and accountability. The paper considers its wider applicability to developing countries. The prerequisites for a successful IT framework are identified as an ability to carry out an independent monetary policy (free of fiscal dominance or commitment to another nominal anchor, like the exchange rate) and a quantitative framework linking policy instruments to inflation. These prerequisites are largely absent among developing countries, though several of them could with some further institutional changes and an overriding commitment to low inflation make use of an IT framework.