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The New Monetary Policy

Implications and Relevance

Edited by Phillip Arestis, Michelle Baddeley and John S.L. McCombie

Beginning with an assessment of new thinking in macroeconomics and monetary theory, this book suggests that many countries have adopted the New Consensus Monetary Policy since the early 1990s in an attempt to reduce inflation to low levels. It goes on to illustrate that the explicit control of the money supply, which was fashionable in the 1970s and 1980s in the UK, US, Europe and elsewhere, was abandoned in favour of monetary rules that focus on interest rate manipulation by the central bank. The objective of these rules is to achieve specific, or a range of, inflation targets.
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Chapter 4: Monetary policy divergences in the euro area: the early record of the European Central Bank

Georgios Chortareas


Georgios Chortareas 1. INTRODUCTION1 This chapter attempts to contribute to our understanding and monitoring of cyclical divergences within the euro area. In particular, we provide some simple analytical tools for assessing the degree of convergence in monetary policy needs in Europe. In contrast to most existing attempts that monitor divergences of real and nominal variables in the euro area, we examine whether the progress towards Economic and Monetary Union (EMU) during the early years of the European Central Bank (ECB) has enhanced convergence in the monetary policy needs of the participating countries or imposed a straitjacket on them. In other words, we focus on divergent policy needs (or warranted policy divergences) rather than divergences of macroeconomic variables. We use simple policy rules as a consistent benchmark to provide a framework for assessing whether the policy needs of EMU participant countries converge. In order to capture any form of divergences we need a benchmark. Such a benchmark would approximate the optimal monetary policy rule that shows how each individual euro area member country would run its monetary policy optimally if it were not a member of a monetary union. Defining ‘optimal monetary policy’ is not an easy task, let alone when one considers more than one country. In this chapter we try to tackle this problem by using Taylor rules as such a consistent benchmark. A Taylor rule is a simple way to describe a monetary policy regime when the interest rate is set in response to inflation and...

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