Stephen Morris and Hyun Song Shin INTRODUCTION The last 15 years have seen a remarkable revolution in both the conduct of and the common understanding of monetary policy around the world. This revolution has encompassed instruments, with an increased emphasis on transparency about short- and medium-run central bank policy planning and a decreased emphasis on intermediate targets such as monetary aggregates. This revolution has also encompassed objectives, with an increased emphasis on medium-run inﬂation targets. However, the objective question cannot be separated from the instrument question. In particular, inﬂation targeting is seen as a key component of transparent monetary policy. At the heart of this revolution is a change in perspective about what monetary policy is all about. The traditional perspective viewed monetary policy as an engineering problem. Central bankers had a set of instruments under their control, faced uncertainty outside their control and sought to manipulate their instruments to achieve targets. The modern perspective views monetary policy as a strategic problem. Most of the action comes neither from instruments under the direct control of central bankers, nor from exogenous uncertainty outside their control, but rather from the actions of market participants who are mostly concerned about variables outside the direct control of the central bank – for example, long-term interest rates – but are acutely aware that everyone else is looking at the central bank for clues about where those variables are headed. As Michael Woodford (2005, p. 2) put it, ‘central banking is not like steering an oil...
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