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Neo-Liberal Economic Policy

Critical Essays

Edited by Philip Arestis and Malcolm Sawyer

Over the past two decades there has been a prevailing shift in economic policy in many countries. This reflects the continuing rise of neo-liberalism – the doctrine that economic policy should ‘leave it to the market’ and that governments should retreat from market intervention. This book provides a balanced and comprehensive appraisal of these important policy developments. The authors examine the most notable trends in neo-liberal economic policy such as the withdrawal from the use of fiscal measures and the reliance on monetary policy. They discuss the neo-liberal view that the causes of unemployment lie in the operation of the labour market, in particular its inflexibility. They also assess the increasing inclination towards the liberalisation and deregulation of markets, most notably financial markets.
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Chapter 2: The theory of credibility: confusions, limitations and dangers

James Forder


James Forder* INTRODUCTION It has become a commonplace of discussion among academics, policymakers, and indeed in opinion-forming society at large, that because of political short-termism, monetary policy is affected by a time-consistency or credibility problem which leads to inflation. The solution to the problem is equally widely held to be the devising of some form of commitment to a policy leading to price stability. It is these doctrines which lie behind much of the conventional wisdom of current macroeconomic policy. They certainly sustain the case for central bank independence; they were clearly instrumental in advancing much of the Maastricht Treaty; and of course they go a long way to explaining the esteem in which central bankers are now frequently held, for in this vision, they are the guardians of our credibility. Widespread as this general view now is, it owes a great deal more to confusion over time consistency and credibility than to the theory’s actual characteristics. In particular, I wish to argue that, properly understood, the theory traces inflation neither to political opportunism nor to short-termism. Furthermore, the literature is far from conclusive in advocating solving the problem by firm commitment to price stability. The construction of the modern policy prescription, then, cannot truly be based on the theory of policy credibility at all. Rather, I shall argue, it is based on a pseudo-credibility theory which, taking common, although more or less unsubstantiated, intuitions and combining them with misstatements of the theory of credibility, arrives at its...

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