Making monetary policy: Objectives and rules

What is it that monetary policy-makers do and how do they do it? The simple answer is that a central banker moves interest rates in order to maintain steady real growth and stable prices. In this essay, I examine the issues that arise in framing the problem faced by monetary policy-makers. I begin with a discussion of how, over the past decade or so, central bank have been made more independent and more accountable. The result has been the virtual elimination of the inflation bias problem that is caused by political interference in the monetary policy process, and better overall macroeconomic performance. The essay proceeds with an example of a formal version of the policy-makers 'problem, describing their objectives and the information they need to formulate a policy rule. I conclude with a discussion of simple versus complex policy rules, the impact of uncertainty on policy-making, and how central bankers use formal modelling in making their day-to-day decisions.