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Re-examining Monetary and Fiscal Policy for the 21st Century

Philip Arestis and Malcolm Sawyer

This book provides a much-needed re-examination of monetary and fiscal policies, their application in the real world and their potential for macroeconomic policy in the 21st century. It provides a detailed discussion and critique of the ‘new consensus' in macroeconomics along with the monetary and fiscal policies encapsulated within it.
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Chapter 4: Can Monetary Policy Affect Inflation or the Real Economy?

Philip Arestis and Malcolm Sawyer


4. Can monetary policy affect inflation or the real economy? 1 INTRODUCTION This chapter is to investigate the extent to which monetary policy can have significant effects on inflation or on the real economy. The use of monetary policy to focus on inflation alone is clearly based on the view that monetary policy will have a significant effect on inflation, and the view that monetary policy will have no effect on the real economy (other than a short-run effect on aggregate demand, which in turn is seen to influence inflation). The objective is to examine monetary policy within the NCM. This involves the manipulation of the key central bank interest rate (often the ‘repo’ rate), with the specific objective of achieving the goal(s) of monetary policy. In this chapter we examine the channels through which changes in the rate of interest may affect the ultimate goal(s) of policy. Indeed, this aspect is of considerable importance and relevance to current monetary developments. A recent conference at the Federal Bank of New York on ‘Financial Innovation and Monetary Transmission’1 readily acknowledged that this change in the conduct of monetary policy, along with financial innovation and the evolving behaviour of firms, has altered the channels through which monetary policy affects the economy. 2 THE TRANSMISSION MECHANISM AND THE CONTROL OF INFLATION The most interesting aspect of the ‘new consensus’ for the purposes of this chapter is the mechanism whereby inflation and...

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