Monetary Policy

Abstract

Mainstream theory and the practice of monetary policy have been identified as converging on a ‘new consensus’, which focuses on the role of the interest rate in a neutral-money framework, with an independent central bank pursuing an inflation target. There are dissenting voices – Monetarists continue to focus on monetary aggregates, while Keynesians focus on the non-neutrality of money and consider a wider range of monetary policy instruments. The interest rate is nevertheless seen by all as the predominant tool of monetary policy. Each approach can be distinguished by the mechanisms of transmission of monetary policy, as the official interest rate impacts on expectations in asset markets and asset pricing on the one hand, and real social experience on the other. It is argued here that there is a disconnect between these two broad channels of transmission; it is through the latter that monetary policy has its real effects. Current issues in the literature are considered, notably those surrounding credibility, expectations, and the relevance of monetary aggregates. The chapter concludes by outlining unresolved issues for the future.