ABSTRACT
One of the oldest ideas in economics is the quantity theory of money; indeed, The New Palgrave describes the proposition that increases in the stock of money eventually cause prices to rise in the same proportion as being' older than economic theory itself' (Bridel, 1989, p. 298). With suitable extensions to recognise the impact of changes in the volume of economic transactions or the velocity of circulation (Fisher, 1911), and more generally the impact of changes in real money demand (Friedman, 1956), this long-standing theory remains the starting point for much modem analysis in monetary economics. In particular, its strong causal link between changes in the money supply and changes in the price level offers a clear strategy for achieving price stability: those responsible for controlling the money supply should be given a statutory duty to implement policy that is consistent with a pre-announced low inflation target. New Zealand was the first country to reform its central bank legislation along these lines (in 1989), and its example has been followed by others since (including Canada in 1991, the United Kingdom in 1997 and the European Central Bank in 1998). The result has been a clear improvement in inflation performance by the end of the twentieth century compared with the previous three decades (see Figure 1.1).
