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Can Monetary Policy Affect The Real Economy?

  • Philip Arestis
  • Malcolm Sawyer

Current monetary policy involves the manipulation of the Central Bank interest rate (the repo rate), with the specific objective of achieving the goal(s) of monetary policy. The latter is normally the inflation rate, although in a number of instances this may include the level of economic activity (the U.S. Federal Reserve monetary policy is a good example of this category). This raises two issues. The first is the theoretical underpinnings of this mode of monetary policy. The second is the channels of monetary policy or, more concretely, the channels through which changes in the rate of interest may affect the ultimate goal(s) of policy. Both aspects are investigated in this paper. Furthermore, we suggest that it is imperative to consider the empirical estimates of the effects of monetary policy. We summarise results drawn from the eurozone, the U.S. and the UK and suggest that these empirical results point to a relatively weak effect of interest rate changes on inflation. We also suggest, on the basis of the evidence adduced in the paper, that monetary policy can have long-run effects on real magnitudes. This particular result does not fit comfortably with the theoretical basis of current thinking on monetary policy.

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Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_355.

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Date of creation: Sep 2002
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Handle: RePEc:lev:wrkpap:wp_355
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  1. Philip Arestis & Kevin McCauley & Malcolm Sawyer, 2000. "An Alternative Stability Pact for the European Union," Economics Working Paper Archive wp_296, Levy Economics Institute.
  2. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  3. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
  4. Paul A. Volcker, 2002. "Monetary policy transmission: past and future challenges," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 7-11.
  5. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  6. Bennett T. McCallum, 2001. "Monetary Policy Analysis in Models Without Money," NBER Working Papers 8174, National Bureau of Economic Research, Inc.
  7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  8. Peersman, Gert & Smets, Frank, 2001. "The monetary transmission mechanism in the euro area: more evidence from VAR analysis," Working Paper Series 0091, European Central Bank.
  9. Frederic S. Mishkin, 1995. "Symposium on the Monetary Transmission Mechanism," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 3-10, Fall.
  10. van Els, Peter J. A. & Locarno, Alberto & Morgan, Julian & Villetelle, Jean-Pierre, 2001. "Monetary policy transmission in the euro area: What do aggregate and national structural models tell us?," Working Paper Series 0094, European Central Bank.
  11. Ben S. Bernanke & Alan S. Blinder, 1988. "Credit, Money, and Aggregate Demand," NBER Working Papers 2534, National Bureau of Economic Research, Inc.
  12. Arestis, Philip & Caporale, Guglielmo Maria & Cipollini, Andrea, 2002. "Does Inflation Targeting Affect the Trade-Off between Output Gap and Inflation Variability?," Manchester School, University of Manchester, vol. 70(4), pages 528-45, Special I.
  13. Kenneth N. Kuttner & Patricia C. Mosser, 2002. "The monetary transmission mechanism: some answers and further questions," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 15-26.
  14. Mojon, Benoît & Kashyap, Anil K. & Angeloni, Ignazio & Terlizzese, Daniele, 2002. "Monetary Transmission in the Euro Area : Where Do We Stand?," Working Paper Series 0114, European Central Bank.
  15. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  16. Laurence H. Meyer, 2001. "Does money matter?," Review, Federal Reserve Bank of St. Louis, issue May, pages 1-16.
  17. Atish Ghosh & Steven Phillips, 1998. "Warning: Inflation May Be Harmful to Your Growth," IMF Staff Papers, Palgrave Macmillan, vol. 45(4), pages 672-710, December.
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