Monetary policy: theory and practice

by Peter Dawson

Introduction

Monetary policy has been at the forefront of government thinking about the workings of the economy for the last 30Monetary policy has been at the forefront of government thinking about 7.he workings of the economy for the last 30years. Together with fiscal policy it is one of the main methods governments employ in the pursuit of their economic objectives of high economic growth, low unemployment and low w-d stable inflation. Traditionally monetary policy has been conducted by central banks on behalf of governments. This means that although the central bank implements monetary policy~ it is the government which makes the final decision about the timing and the magnitude of the change. Recently governments in a number of countries have granted varying degrees of independence to central banks. In the UK, for example, the Bank of England (BoE) was given 'operational' independence in 1997 granting it a degree of discretionary power in the setting of interest rates and other monetary variables.

The importance of monetary policy can be found in the increased media interest in monetary policy matters. Barely a day goes by without some mention of monetary policy Newspapers are filled with speculation about the likely moves monetary authorities will take in order to stabilise the economy Remarkably there is now broad agreement amongst economists that monetary policy is the only policy tool capable of reducing business-cycle fluctuations. However, this does not mean that monetary policy is no longer considered to be controversial. There is still disagreement amongst economists and central bankers over how it should be implemented and who should control it.
This chapter addresses three fundamental questions. First, what is the role 3Ild purpose of monetary policy; what is it used for and how does it