Monetary Transmission Lags and the Formulation of the Policy Decision on Interest Rates

Abstract

Although it is a generally accepted stylised fact that, as Milton Friedman noted, the monetary policy transmission mechanism has ‘long and variable lags’, most of the early theoretical work on these issues, e.g. the rules vs. discretion debate, proceeded on the assumption that monetary policy measures were instantly transmitted to inflation, e.g. Barro-Gordon (1983), Cukierman (1992). Thus in his basic model (Chapter 3, p. 28), Cukierman states that “Abstracting from real shocks, growth and changes in velocity, the rate of inflation is equal to the rate of monetary growth m. Hence inflationary expectations are equal to expected money growth me, and the shortrun Phillips relation can be restated as N − Nn = α (m−m^e),” where N is employment and Nn the natural rate of employment.

My thanks are due to Bill Allen, Nicoletta Batini, Spencer Dale, John Flemming, Mervyn King, Ed Nelson, Lars Svensson, Dan Thornton and John Vickers for helpful comments and suggestions. The idiosyncratic views and remaining errors remain, however, entirely my own personal responsibiligy.