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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 13: Monetary models and inflation targeting in emerging market economies

Valpy FitzGerald


13. Monetary models and inflation targeting in emerging market economies Valpy FitzGerald 1. INTRODUCTION As Mankiw (2003) points out in a recent survey of monetary economics, while traditional approaches to monetary policy relied upon transmission to lower inflation through output (and employment) depression via the Phillips curve, this tradeoff seems to have been overcome in advanced economies through labour market reform, which has allowed low inflation and low inflation to co-exist.1 Modern scholars now reach a similar conclusion by a different route – that of independent and unpredictable monetary shocks. In a sense, the modern approach to monetary economics in emerging market economies is similar, although the shocks in question are those of international financial markets on the open developing economy: the exchange rate is thus far more important than textbook monetary theory2 would allow. Moreover, the Phillips curve had never been a convincing model of inflation in developing economies due to the extent of disguised unemployment. None the less, the International Monetary Fund (IMF) strongly holds the view3 that central bank monetary discretion is inherently inflationary,4 and thus makes binding monetary rules a condition for official financial assistance to emerging market governments. The ‘new monetary policy’ (NMP) is understood to include: a numerical and official inflation target; monetary policy exercised through interest rates; an independent central bank; and no other objectives of monetary policy (Arestis and Sawyer, 2003). The monetary policy rule that generates interest rate responses to inflationary...

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