Monetary Policy: Practice Ahead of Theory

Abstract

This chapter describes monetary policy which aims at maintaining price stability. It is not known whether the great stability will continue, as it has for more than a decade now. In part, it depends upon whether our framework of inflation targeting can respond to the economic shocks that will undoubtedly be visited upon us in the years ahead. It examines what inflation targeting really means, why it has been successful in Britain and elsewhere, and what challenges it faces in the years ahead. The source of monetary policy's influence over output and employment lies in frictions, which mean that prices and wages do not adjust instantaneously to clear markets whenever demand and supply are out of balance. Monetary policy rules have become a major area of research.

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