How the World Achieved Consensus on Monetary Policy

Abstract

This article tells how the world achieved a working consensus on the core principles of monetary policy. The story begins with the muddled state of affairs in the late 1970s. It then asks: How did Federal Reserve policy produce an understanding of the practical principles of monetary policy? How did formal institutional support abroad for targeting low inflation follow from an international acceptance of these ideas? And how did a consensus theoretical model develop in academia? The article tells how the modern theoretical consensus known as the New Neoclassical Synthesis (aka, the New Keynesian model) reinforces key advances: the priority for price stability, the targeting of core rather than headline inflation, the importance of credibility for low inflation, and preemptive interest rate policy supported by transparent objectives and procedures. The conclusion identifies important practical issues that remain to be explored in theory.