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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 5: Stock market prices and the conduct of monetary policy under the New Consensus Monetary policy

Nigel Allington and John McCombie


Nigel Allington and John McCombie 1. INTRODUCTION In this chapter we consider the broad question of whether or not central banks should take into account, either explicitly or implicitly, the rate of asset price inflation, especially when this is much more rapid than the growth of the CPI (consumer price index), in the determination of the nominal interest rate. We shall largely focus on stock market prices and confine our attention to the advanced countries. (Emerging markets raise additional considerations, such as poor prudential financial regulation.) This immediately raises both normative and positive issues. First, should the central bank attempt to influence asset prices through the use of interest rates and then, if it should, in what circumstances? Second, if the central bank should intervene, how effective is the use of interest rates in achieving this? If the answer to the latter is that it is not very effective, then should other instruments be used and, if so, what instruments? This merges into the wider question as to whether interest rates are effective in controlling inflation, per se, through influencing aggregate demand, as the New Consensus Monetary Policy suggests. The New Consensus Monetary Policy, which suggests that the central bank should target inflation with no explicit consideration given to asset prices, is discussed in Chapters 2 and 6 (this volume). Therefore we begin by reviewing the evidence as to whether or not the crash of an asset price bubble has any serious adverse effects...

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