Issues in Monetary Policy: The Relationship Between Money and Financial Markets


Since the Bank of England was made independent in 1997, the conduct of monetary policy has been relatively uncontroversial. The debates between Keyneisans, monetarists and supporters of fixed exchange rate mechanisms now appear very distant.

Despite the apparent consensus there are many issues related to the conduct of monetary policy that are not yet settled and which will soon come to the fore. Is the current form of independence for the Bank of England appropriate? Should a ...

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Since the Bank of England was made independent in 1997, the conduct of monetary policy has been relatively uncontroversial. The debates between Keyneisans, monetarists and supporters of fixed exchange rate mechanisms now appear very distant.

Despite the apparent consensus there are many issues related to the conduct of monetary policy that are not yet settled and which will soon come to the fore. Is the current form of independence for the Bank of England appropriate? Should a central bank target inflation or the prices level? How does a central bank deal with asset price deflation? Should more account be taken of monetary aggregates? Should central banks target asset prices? What is the relationship between the money supply and asset price inflation? How should central banks ensure financial stability?

The IEA was at the forefront of changing the parameters of the debate surrounding monetary policy in the 1970s and 1980s. This text, brings together some of the leading authors in the field, including the current Governor of the Bank of England, to discuss current issues in monetary policy and the relationship between monetary policy and financial markets. It is appropriate for undergraduates and postgraduates in economics and finance as well as for practitioners in financial markets.

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Editorial Reviews

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"...(people can) gain so much more from this book than the review can do justice to..."  (Credit Control, June 2006)
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Product Details

  • ISBN-13: 9780470018194
  • Publisher: Wiley
  • Publication date: 4/21/2006
  • Edition number: 1
  • Pages: 210
  • Product dimensions: 6.54 (w) x 9.72 (h) x 0.61 (d)

Meet the Author

Kent Matthews is the Julian Hodge Professor of Banking andFinance at Cardiff University. He trained at the London School ofEconomics, Birkbeck College and Liverpool University and has heldprevious academic positions at Liverpool University, LiverpoolBusiness School. He has held visiting posts at the CatholicUniversity of Leuven Belgium, Humbolt University, Berlin andUniversity ofWestern Ontario, Canada as well as professional postsat the National Institute of Economic & Social Research, theBank of England and Lombard Street Research Ltd.

Philip Booth BA, PhD, FIA, FSS is Editorial and ProgrammeDirector at the Institute of Economic Affairs and Professor ofInsurance and Risk Management at Cass Business School, CityUniversity. He has previously worked as a special advisor onfinancial stability issues for the Bank of England. Philip Booth iseditor of the journal Economic Affairs and associate editorof the British Actuarial Journal. He is a Fellow of theInstitute of Actuaries and of the Royal Statistical Society.Amongst previous books he has written are InvestmentMathematics (Wiley), Modern Actuarial Theory andPractice (CRC/Chapman Hall) and The Way Out of the PensionsQuagmire (Institute of Economic Affairs). He teaches,researches and writes in the areas of finance, investment andsocial insurance.

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Table of Contents

List of Contributors.

1 Issues in Monetary Policy (Kent Matthews and PhilipBooth).

1.1 Introduction.

1.2 The monetarist counter-revolution.

1.3 Practice ahead of theory.

1.4 The dangers of practice without theory.


2 Monetary Policy: Practice Ahead of Theory (MervynKing).

2.1 Introduction.

2.2 What can monetary policy do?

2.3 Learning and its implication for monetary policy.

2.4 Inflation targeting as a framework which accommodateslearning.

2.5 Conclusion.


3 Are the Structure and Responsibilities of the Bank ofEngland Optimal and If Not, Does It Matter? (David B.Smith).

3.1 Introduction.

3.2 Current arrangements.

3.3 The conventional theoretical macro model (CTMM).

3.4 How the Bank’s main macro model constrained themonetary debate.

3.5 The new Bank of England quarterly model.

3.6 The monetarist case for a big central bank.

3.7 Lessons from Britain’s monetary history.

3.8 Main conclusions.

References 37

4 Why Price-Level Targeting is better than InflationTargeting (Andrew Lilico).

4.1 Introduction.

4.2 How do inflation targeting and price-level targetingdiffer?

4.3 What is there to gain from long-term price stability?

4.4 Inflation volatility is not same thing as inflationuncertainty.

4.5 Price-level targeting generates its own credibility.

4.6 Price-level targeting is self-regulating.

4.7 Price-level targeting offers escape from a low-employmentequilibrium.

4.8 The ‘costs’ of price-level targeting havecorresponding benefits.

4.9 Price-level targeting vs. average inflation targeting.

4.10 The history of price-level targeting.

4.11 Conclusion.


5 A Price Targeting Regime Compared to a Non Price TargetingRegime. Is Price Stability a Good Idea? (KeithPilbeam).

5.1 Introduction.

5.2 The ultimate objective of economic policy.

5.3 Modeling economic shocks.

5.4 The model.

5.5 Determining Equilibrium.

5.6 A money demand shock.

5.7 Aggregate demand shock.

5.8 An aggregate supply shock.

5.9 The search for an indicator.

5.10 Conclusions.


6 Optimal Monetary Policy with Endogenous Contracts: Is therea Case for Price-Level Targeting and Money Supply Control?(Patrick Minford).

6.1 Introduction.

6.2 Considerations in designing monetary policyarrangements.

6.3 Monetary policy: Is inflation targeting the best we cando?

6.4 Interest rate control – what does it do?

6.5 Money supply targeting and feedback rules – astochastic simulation analysis.

6.6 Conclusions.

Annex: The representative agent model (RAM).


7 Forecasting Inflation: The Inflation ‘FanCharts’ (Kevin Dowd).

7.1 Inflation forecasting.

7.2 The inflation fan charts.

7.3 The Bank’s forecast inflation density function.

7.4 Evaluating the Bank’s inflation forecasts.

7.5 Conclusions.

Annex: The two-piece normal density function.


8 Asset Prices, Financial Stability, and the Role of theCentral Bank (Forrest Capie and Geoffrey Wood).

8.1 Introduction.

8.2 What is price stability?

8.3 Financial stability.

8.4 The lender of last resort.

8.5 Do asset prices matter?

8.6 Should institutions be propped up?

8.7 Financial benefits of monetary stability.

8.8 Conclusions.


9 Money, Asset Prices and the Boom-Bust Cycles in the UK: AnAnalysis of the Transmission Mechanism from Money to Macro-EconomicOutcomes (Tim Congdon).

9.1 Introduction.

9.2 Traditional accounts of the transmission mechanism.

9.3 Asset prices in the traditional accounts.

9.4 The ownership of capital assets in the UK.

9.5 Asset prices and economic activity.

9.6 Conclusion: Money and asset prices in the transmissionmechanism.

Annex: Econometric analysis of one type of real balanceeffect.


10 Money, Bubbles and Crashes: Should a Central Bank TargetAsset Prices? (Gordon T. Pepper with Michael J.Oliver).

10.1 Introduction.

Part A: The monetary theory of bubbles and crashes.

10.2 Types of traders in securities.

10.3 Extrapolative expectations.

10.4 Debt-deflation.

Part B: Should a central bank target asset prices?

10.5 Preventing financial Bubbles.

10.6 Conclusions – an answer and a question.

Annex: Disequilibrium.


11 Monetary Policy and the Bank of Japan (JohnGreenwood).

11.1 Introduction.

11.2 Japan’s golden era in monetary policy,1975–85.

11.3 How monetary policy went off the rails, 1985–89.

11.4 The bursting of the bubble, 1989–91.

11.5 Assessment of policy responses.

11.6 Monetary policy – deliberate yen depreciation.

11.7 Monetary policy – government borrowing from thebanks.

11.8 Restructuring policies.

11.9 Conclusion.


Appendix 1: Unemployment versus Inflation? An Evaluation ofthe Phillips Curve (Milton Friedman).

Appendix 2: The Counter-Revolution in Monetary Theory(Milton Friedman).


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