10.3 Monetary Policy and Interest Rates

4. In a noninflationary environment be pragmatic and eclectic; use the deliberately vague concept "credit conditions" as a target that may or may not, depending on circumstances, involve what is happening to interest rates or to monetary aggregates.
5. Adopt low inflation as a priority goal, and only use discretionary policy to deal with other goals, such as smoothing the business cycle, if (a) action is definitely warranted and (b) doing so will not jeopardize the inflation goal.
6. Any use of the interest rate as a policy tool (as opposed to a "target") needs to be in terms of the real interest rate. For example, an increase in expected inflation of 1 percent should require a greater increase in the nominal interest rate (to imply a higher real interest rate) to fight the inflation. This appears to be the way the Fed is currently applying monetary policy.
These points summarize much of what the Fed has learned, often the hard way, since its creation in 1913:
Be pragmatic: do what works; use interest rates (or monetary aggregates) as an indicator of monetary policy only when circumstances warrant.
Be eclectic: do not pay undue attention to any one polar view of the economy, such as that of the monetarists, the Keynesians, or the supply-siders.
Be flexible: do not commit yourself publicly to a specific policy in case it becomes necessary to alter course; criticism is more easily deflected this way.
Be careful: move only when the fight move is unequivocally clear; never try to "fine-tune" the economy.
Exploit strengths: because inflation is always and everywhere a monetary phenomenon, make inflation a top priority.
This growth in Fed wisdom has come at a good time. Many believe that because of crowding out and political bickering, fiscal policy has become undependable, rendering monetary policy our main macroeconomic policy tool.
Media Illustrations
Example 1
The bond markets were stunned by the shock of Thursday's flash second-quarter news that the economy has grown three whole percentage points. You and I would say that's good news. But the bond markets' terrified interpretation last Thursday was that it might encourage the private sector to borrow, nudging up interest rates. Add that discomforting prospect to the other horrifying disclosure that, at last reading, our

 



Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

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