bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

344 MONETARY ECONOMICS
it inflation target. Instead of adopting an intermediate target in the hope that
it had some reliable connection with the ultimate objective of policy, the ultimate
objective itself would be directly targeted. Interest rates were now set
with a view to their effects upon inflation some eighteen months ahead. One
way of interpreting inflation targeting is to see it as an encompassing case of
monetary targeting or exchange rate targeting. In the latter cases, the authorities
are setting interest rates with a view to achieving a low inflation rate,
using just one source of information (monetary growth, exchange rate etc.)
disregarding all else. 16 In an inflation targeting regime, interest rates are still
set with the same objective but the decision draws upon all relevant variables.
These include money and credit growth, the exchange rate, wage trends, asset
prices, employment figures, the ‘output-gap’, surveys of ‘confidence’ etc. and
may change over time. 16
The second feature was a much greater degree of openness and transparency
in policy making. By the time the Bank of England gained its instrument
independence in 1997, this contained five elements. Firstly, a quarterly
Inflation Report would be published showing the information on which the
Bank was making its interest rate decisions. Secondly, the minutes of the
meetings between the Governor of the Bank of England and the Chancellor of
the Exchequer at which interest rates were set were also published. After
1997, when the Bank of England was given independence in the setting of
interest rates, the latter was replaced by the minutes of the monetary policy
committee (MPC) which again gave commentators some insight into how
decisions were arrived at and also revealed the pattern of voting. Thirdly, representatives
of the Bank and the MPC could be called to give evidence on
their conduct to the Treasury Select Committee. Fourthly, if inflation were
to deviate by more than one per cent from target, then the MPC would be
required to write an ‘open letter’ to the Chancellor of the Exchequer in order
to explain the horizon over which it intended to bring it back into the target
range (in effect, making explicit the policy reaction function). Finally, the
Bank of England’s Annual Report would be subject to parliamentary scrutiny
and debate. The argument behind this openness was that, over time, private
sector agents would ‘learn’ how the MPC decided on the appropriate interest
rate and would eventually be able to anticipate the Bank’s next decision.
Eventually, changes in interest rates would cease to be ‘news’ since, by the
time they were announced, they would already be incorporated in private sector
decisions. The economic advantage of this, rather like the advantage of
low and stable inflation rates, is that another source of ‘shocks’ to the economy
would be eliminated and fewer incorrect decisions would be made by private
sector agents. It is worth noting that the lack of comparable openness has