ABSTRACT
Monetary policy is aimed at maintaining price stability. From the end of the Second World War until the mid to late 1970s, the majority view of academic economists and policy makers alike was that monetary policy had rather little to do with inflation, and was largely ineffective as an instrument of demand management. The academic literature on monetary policy rules has performed a great service in emphasising the importance of expectations. A basic proposition common to most models of the economy is that if demand exceeds the supply capacity of the economy then there will be upward pressure on wage and price inflation. The empirical evidence suggests that inflation targeting has helped to confer tangible benefits. One test of whether inflation expectations are well anchored is the volatility of long-term interest rates. Inflation targeting is a framework for making and communicating decisions. The implications of an inflation target for central bank communications are natural enough.
