Central Banking: Theory and Practice in Sustaining Monetary and Financial Stability

Chapter 6Monetary Policy RegimesWhat Monetary Policy Rules a Central Bank Can Use to Achieve Monetary Stability

Learning Objectives

• Describe various monetary policy regimes that central banks have adopted since the end of the Bretton Woods system.
• Explain the pros and cons of adopting an exchange rate targeting regime.
• Explain the pros and cons of adopting a money supply targeting regime.
• Explain the pros and cons of adopting an inflation-targeting regime.
• Explain the pros and cons of unconventional monetary policy in the case of quantitative easing.

As discussed in Chapter 5, the concept of the time inconsistency problem suggests that without a monetary policy rule guiding how the central bank regulates money conditions in the economy, the conduct of monetary policy would not be credible nor effective. Without a monetary policy rule constraining the central bank on monetary-policy decisions, the public might not believe that the central bank would ultimately keep the promise of price stability, since there are always incentives for the central bank to backtrack on the policy and try to push unemployment down further, possibly at the cost of price stability. Without a monetary policy rule, the public’s inflation expectations might thus not be properly anchored, and the central bank, for all its good intentions, might be unable to successfully control inflation and deliver price stability as promised. To effectively conduct monetary policy, the central bank thus needs to ...