The Enigma of the Ineffectiveness of Interest Rate Policy in the 1990s

Most leading macroeconomic theories postulate that nominal interest rate reductions, as implemented by central banks in many countries over the past several years, operate towards stimulating the economy. Since about the 1980s, central banks have come to emphasize interest rates in their official publications as the dominant tool of monetary policy implementation. It has come to be described as the ‘new consensus’ in macroeconomics (Arestis and Sawyer, 2002). In their discussion of the Bank of England model, Arestis and Sawyer note that monetary aggregates have been relegated to a minor role, while ‘interest rate policy has become demand policy’ (2002, p. 12): Policymakers attempt to achieve a certain inflation goal by using their control over interest rates to restrain the total demand for goods and services in the economy. (Arestis and Sawyer, 2003a, p. 9) Monetary policy can be seen as aggregate demand policy in that the interest rate set by the central bank is seen to influence aggregate demand, which, in turn, is thought to influence the rate of inflation. (Arestis and Sawyer, 2003a, p. 17) Taylor (2000) reflects the consensus view, when he reports his finding that even if there are alternative views of the monetary transmission mechanism, ‘the same simple monetary policy rule — one in which the central bank’s target short-term interest rate reacts to inflation and to real output — would perform well’ (p. 60).