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 and policy objectives is too unstable for their policy use.
• Monetary action should instead be targetted directly on inflation, 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. .