Chapter 17
The Conduct of Monetary Policy: Strategy and Tactics
Chapter 17 outlines the goals, strategies, and tactics of central bank policymaking. It starts by
laying out modern theories of central banking: It first discusses the price stability goal and the
role of a nominal anchor in solving the time-inconsistency problem, and then discusses the other
goals of monetary policy and why price stability is now viewed as the primary goal of monetary
policy.
The chapter then goes on to discuss two monetary policy strategies. The first is inflation
targeting, which involves announcement of an inflation target objective, with a commitment by
the central bank to achieve it. The Fed has been considering adoption of an inflation target, and I
was a strong proponent of this policy framework when I was a governor of the Federal Reserve.
The second, what I refer to as the “Just Do It” approach, is the one the Federal Reserve used
before it adopted inflation targeting, which entails a strong commitment to control inflation, but
without an explicit inflation target. There is an additional monetary policy strategy that central
banks used in the past, but not currently—monetary targeting. For those instructors who would
like to cover this material, I have provided an appendix to Chapter 17 found in MyLab
Economics that covers monetary targeting. I have found that discussing the pros and cons of
different monetary policy strategies piques students’ interest. One teaching technique is to have
students debate which strategy is best.
The chapter then moves on to discuss monetary policy tactics: in particular, what policy
instrument should be chosen to conduct monetary policy. Figures 3 and 4 illustrate why targeting
on a monetary aggregate like nonborrowed reserves implies a loss of control of interest rates like
the federal funds rate, while targeting on the federal funds rate implies a loss of control of
monetary aggregates. This analysis can also be done in terms of the supply and demand for
money framework. Indeed, covering this topic is an excellent way of providing students with
another application to give them practice with the supply and demand analysis for the market for
reserves or the market for money.
The chapter has a second appendix in MyLab Economics that provides a historical discussion of
how the Fed has conducted monetary policy over the last 90 years. It presents students with
many real-world examples that make the study of monetary policy more concrete. It also
provides students with a review of the money supply process and how the Fed’s policy tools
work, thus giving them another pass at this material, which should solidify their understanding of
it. Finally, it will give students some perspective on where monetary policy may be heading in
the future.