Uk Economic Policy

At present, UK monetary policy is founded on an inflation target and central bank independence. Critically assess the extent to which the theoretical and empirical work of macroeconomists has influenced this current monetary policy framework.

Developments in macroeconomic policy are generally as a result of critical analysis over time and each of the Macroeconomists reviewed in this essay have provided this for their predecessors. In our current framework it is evident that the policies applied are all influenced, in part, by these economists.

To understand the need for an inflation target it is important that we understand what the real costs of inflation are and why inflation must be controlled. The consensus view is that inflation, especially if it is unanticipated, has real economic costs (Snowdon and Vane, 2005). In terms of anticipated inflation it is believed that there are still welfare costs. These are shoe leather costs and menu costs (Snowdon and Vane, 2002). Shoe leather costs are prevalent as a result of the increase in time deposits, in an inflationary environment, so that the interest earned will partially offset the nominal costs of inflation. Menu costs result from the labour, paper and ink cost of re-pricing goods due to inflation. The costs of inflation have more impact when the inflation is unanticipated, this can lead to reductions in the real wage rate.

The roots of the UK’s current monetary policy framework, based on inflation targeting and central bank independence, can be traced back to Friedman’s 1968 paper, The Role of Monetary Policy. In this paper Milton Friedman reintroduced Monetary Policy as a viable method to manage the economy. He put forward that the price level was the most important parameter in an economy but conceded that it was also the most difficult to control due to the effect of time lags. In this paper he also acknowledged the impact of time on economic research, stating, “Perhaps, as our understanding of economic phenomena advances, this situation will change.” He asserted this in reference to his comment on attempts to directly control price level, and the likeliness that they would become a monetary disturbance (Friedman, 1969). Friedman’s preferred method of monetary management was to explicitly target quantity of money growth at a stable rate. In his opinion the optimum would be between 3 and 5%. By targeting the rate of growth in such a way he believed it would be possible to control price level indirectly, ensuring that it increased or decreased at a low and steady rate.