bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

unanticipated monetary shocks had real effects. The great majority suggested
that monetary policy had real effects, whether it was anticipated or
not. 3 More recent testing has not altered that balance.
Quite apart from the formal testing, it seems hard to accept that major
booms and recessions can be explained by frequent, large and persistent
errors in the inflation expectations of market agents, especially given the
quantity and quality of information that is available about current changes
and likely future movements of the price level. It seems far more likely that
monetary policy’s impact on real variables is the result of one or more of the
arguments critical of the new classical model. The most likely candidate is
the failure of real world markets to clear perfectly and instantaneously.
8.5 Credibility and time consistency
THE TRANSMISSION MECHANISM OF MONETARY POLICY - II 225
Nonetheless, to develop our next set of propositions, we need to ignore the
criticisms of the new classical model. We must return to the policy irrelevance
proposition and to the idea that the expectations of market agents
regarding the rate of inflation depend on their view of the likely behaviour
of the authorities, specifically the expected rate of growth of the money supply.
In such a world, the monetary authorities could assist market agents in
the formation of expectations by following a clear monetary rule or, at least,
announcing targets for the rate of growth of the money supply. There would
be no point in attempting to mislead market agents because, to be effective,
they would need to do so in a consistent direction. That is, if the authorities
wanted to reduce unemployment they would always need to cause the
money supply to grow at a faster rate than their announced target. However,
market agents would soon realize that the money supply always grew at a
faster rate than the authorities’ target and would adjust their inflation expectations
accordingly. In other words, agents would make a judgement
regarding the credibility of the policy announcements of the authorities.
The credibility of a particular policy statement would depend on:
(a) the performance of the policy authorities in the past (their reputation)
and
(b) the nature of the policy institutions.
Even if the policy authorities were not to be trusted, institutional
arrangements might prevent them from attempting to mislead the public.
For example, the authorities might be pre-committed to following a partic-