bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

312 MONETARY ECONOMICS
The reasons for its end are various but many of them had to do with
changes in the monetary and financial system which made the behaviour of
monetary aggregates less important and also less controllable. We shall see
that there is a certain irony here, since many of the innovations which undermined
monetary targeting sprang from a policy of financial deregulation
introduced by the same government which was at the same time insisting on
the importance of hitting its monetary targets. In Section 11.3 we look at the
process of financial innovation and how it undermined both the rationale and
the feasibility of monetary targets during the 1980s.
In Section 11.4 we look at how monetary policy has evolved since the
demise of monetary targeting. This takes us through a period in which the
authorities targeted the exchange rate (against the Deutschemark) and then
targeted the rate of inflation itself. In these circumstances, and in contrast
with those outlined in 11.2, money and credit growth rates are demoted, firstly
to being a subsidiary target and then to at most one of many possible indicators
of the future trend in inflation. In these circumstances, the central bank
sets interest rates with an eye on the likely rate of inflation some eighteen to
twenty-four months ahead. Given the level of interest rates, banks are free to
meet all creditworthy demand for loans that are forthcoming and the central
bank ensures that sufficient reserves are available. These ‘loans create
deposits’ and the money supply has become endogenous. We close Section
11.4 by looking at how the central bank sets interest rates and at why, in the
present conduct of monetary policy, the money supply is endogenous.
Section 11.5 summarises.
11.2 UK monetary policy before 1985
As we shall see in a moment, UK monetary policy passed through a number
of very different phases between the end of World War II and the mid-1980s.
Dividing the historical record into precise sub-periods is always controversial,
but we can probably say that there were three identifiable phases — 1945 to
1971, 1971 to 1979 and 1979 to 1985. It was only in the last of these periods
that monetary policy tried to focus explicitly and single-mindedly upon the
growth of the money stock, though shifts in this direction can be seen during
the second period, roughly the 1970s.
Adopting a monetary policy in which control of the monetary aggregates
is the main objective must obviously be based upon some theoretical notion
of how monetary variables affect the rest of the economy and specifically
upon the idea that the aggregates themselves are capable of having an independent,
causal effect. The thinking is broadly that which we saw in Section