Edited by John B. Davis and Wilfred Dolfsma
Chapter 26: Monetary Policy
Sheila C. Dow Introduction The theory of monetary policy has gone through marked changes over the last 50 years, with the focus changing in turn from liquidity (in the Radcliﬀe approach) to the money supply and money targeting (in the monetarist approach) to the money supply and inﬂation targeting (the new classical approach) to the current emphasis on the interest rate within an inﬂation-targeting framework, relying heavily on the forward-looking expectations of market participants (the new Keynesian approach). This last approach has been dubbed the ‘new consensus’, reﬂecting a convergence of view among theorists and also a convergence between theorists and policy-makers. This view is also embedded in the institutional arrangements for monetary policy, whereby policy is made by a committee within an independent central bank. Yet there are still alternative viewpoints, notably the continuing emphasis by monetarists on monetary aggregates, and the Keynesian focus on the interdependence of real and ﬁnancial variables. There is, further, some evidence of a weakening of the consensus, as doubts emerge as to the capacity of interest rate policy to control inﬂation. The theoretical analysis and much of the policy analysis are couched in macroeconomic terms, that is, in terms of variables which aggregate individual experience, and emphasize outcomes rather than processes. Macroeconomic analysis illuminates general relationships between data series, providing a clue to possible underlying relationships at the level of experience, at the same time as capturing something of the macroeconomic backdrop of individual experience. The latter is...
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