Globalization’s impact on the relationship between short- and long-term interest rates poses potentially formidable challenges for central banks around the world. It underscores the importance of formulating monetary policy in a credible, consistent and forward-looking way and better communicating it to the public. Adopting these virtues will help anchor long-run inflationary expectations and decrease associated risk premiums. It will also help the public better understand central banks’ behavior and decrease the perceived uncertainty of future monetary policy. Globalization may also call for greater cooperation and coordination of policy worldwide because international financial conditions increasingly affect the price of credit in all major countries. ; New economic realities and relationships have challenged the basic assumptions of monetary policy in the past. Two decades ago, for example, a strategy of relying on monetary aggregates proved ineffective, leading the Fed to shift its primary policy focus to actual inflation and capacity measures. Now, just as then, a deeper understanding of the factors in play will allow central bankers to achieve their mandate of non-inflationary economic growth.
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Article provided by Federal Reserve Bank of Dallas in its journal Economic Letter.