More efficient monetary policy has been the driving force behind the improved
macroeconomic performance of the world economy since the early 1990s. That is the
conclusion of new research by Professors Stephen Cecchetti, Alfonso Flores-Lagunes
and Stefan Krause, published in the April 2006 Economic Journal.
The 1990s were a remarkable decade. Information technology (IT) came of age, bringing
the benefits of computerisation into our lives through everything from cars to dishwashers.
Because of the internet, incredible libraries are now available in our homes and offices.
What may be even more extraordinary is that the 1990s brought unprecedented economic
stability. Compared with the 1980s, growth was higher, inflation was lower and both were
more stable nearly everywhere. Inflation volatility fell across the world, while output
variability declined in more than half of the 23 industrialised countries for which data are
available.
There are three possible explanations for this phenomenal worldwide economic
performance:
• The first is luck – the 1990s simply happened to be an exceptionally calm period.
• The second is that economies have become more flexible in responding to the everpresent
unexpected changes in the economic environment.
• And the third is that monetary policy-makers figured out how to do their job more
effectively.
Which one of these explanations is most likely?
With the major economic crises in Latin America and Asia, the Russian debt default, the
collapse of Long-Term Capital Management, and the volatility of raw material prices, it is
difficult to argue that the stability of the 1990s was simply good fortune.
Instead, something must be cushioning the impact of external shocks. While advances in IT
surely allow manufacturers to respond more flexibly to changes in demand for their
products, these changes have been too gradual to explain the relatively sudden decline in
volatility we have seen.
This study examines the third possibility – that the stability of the 1990s is the consequence
of improved monetary policy. Today, economists have a much better understanding of how
to implement monetary policy than they did as recently as 20 years ago. To succeed in
keeping inflation low and stable while at the same time keeping real growth high and stable,
central bankers must focus on raising interest rates when inflation goes up and lowering
them when inflation goes down.
These researchers develop a method for measuring the contribution of improved monetary
policy to observed changes in macroeconomic performance, and apply it to 24 countries.
The estimates suggest that improved policy-makers have played a stabilising role in 21 of
the 24 countries. Seventeen countries experienced smaller shocks, but overall this had a
modest impact on economic performance.
Overall, the researchers conclude that improved central bank policy accounts for roughly
half of the reduction in the volatility of growth and inflation. More efficient monetary policy
has been the driving force behind improved macroeconomic performance.
ENDS
Notes for editors: ‘Has Monetary Policy Become More Efficient? A Cross-country Analysis’
by Stephen Cecchetti, Alfonso Flores-Lagunes and Stefan Krause is published in the April
2006 issue of the Economic Journal.
Stephen Cecchetti is at Brandeis University. Alfonso Flores-Lagunes is at the University of
Arizona. Stefan Krause is at Emory University.
For further information: contact Alfonso Flores-Lagunes on +1-520-626-3165 (email:
alfonso@eller.arizona.edu); or Romesh Vaitilingam on 0117-983-9770 or 07768-661095
(email: romesh@compuserve.com).