The Uncertain Future of Monetary Policy

Although the conduct of monetary policy has always been enveloped in controversy, its objectives have by and large not been controversial. These are a stable price level to give a constant purchasing power of money, a fully employed economy and reasonably stable interest rates. The problem is that these are usually incompatible, giving rise to a conflict of objectives. It falls upon the operating principles on which the conduct of monetary policy is based to resolve the conflict. The principle once followed of currency convertibility resolved the conflict in favour of a fixed value of money by giving priority to convertibility into gold, which imposed a constraint on the pursuit of the other objectives. When convertibility under the gold standard was restricted and then finally ended, the conflict of objectives became unresolved, which as could be expected has left us with continuing controversy. The two other most well-known operating principles to guide the conduct of monetary policy are interest-rate targeting and monetary targeting. Both have run into serious difficulties and have been rejected as operating targets, although not abandoned completely; both continue as partial guides for policy. What operating principle will or can in the future be the basis for the conduct of monetary policy remains unsettled and unclear. Dissatisfaction with the lack of commitment to stability of prices or foreign exchange rates has led some experts (such as my colleague Robert Mundell) to argue for a return to convertibility, but that solution to the conflict of objectives has little support.