Monetary policy/Addendum

The Jackson Hole consensus

(Summarised from a speech by Charles Bean at the 2010 Jackson Hole Conference)

• Discretionary fiscal policy is rejected as an instrument of demand management.
• The principal economic policy instrument is to be monetary policy, operated by the management of short-term interest rates.
• The monetary transmission mechanism operates mainly through longer-term interest rates, asset prices and expectations of future inflation.
• The conduct of monetary policy is best delegated to an independent central bank.
• The link between intermediate monetary targets (such as the money supply and policy objectives is too unstable for their policy use, although they may serve as indicators of future demand and inflation.
• Monetary action should instead be targetted directly on the price level, but with some "constrained discretion" towards the pursuit of output stability
• Asset markets provide an efficient means of risk distribution and are not normally amenable to monetary policy action
• Financial markets are generally well developed and well regulated, and systematic crises are therefore unlikely.

The Taylor rule

The rule states that the real short-term interest rate (that is, the interest rate adjusted for inflation) should be determined according to three factors:

• where actual inflation is relative to the targeted level that the Fed wishes to achieve;
• how far economic activity is above or below its "full employment" level; and,
• what the level of the short-term interest rate is that would be consistent with full employment.
  

The rule recommends a relatively high interest rate (that is, a "tight" monetary policy) when inflation is above its target or when the economy is above its full employment level, and a relatively low interest rate ("easy" monetary policy) in the opposite situations. .