INTRODUCTION

Monetary policy is the most flexible economic policy tool of government, and possibly its most potent one as well. Nevertheless, as World War II ended, the experience of the 1920s and 1930s revealed a deep mistrust of monetary policy, and perhaps to a greater extent, of central bankers. Governments yearned for some form of stability, after decades of large fluctuations in the price level and in other major macroeconomic aggregates. Policy coordination failed and there was a strong undercurrent of desire for countries to find their own destiny, as it were, in economic terms. While fiscal policy would dominate the scene as the principal tool of policy, three concurrent forces lead to a shift back to the view that the central bank must occupy a central place in the implementation of economic policy. First, exchange rate stability is an illusion and must of necessity come in conflict with domestic objectives that diverge across countries. Second, the growth of trade and of capital mobility leads to international imbalances that are exacerbated by artificial attempts to maintain exchange rate regimes ill suited to such an environment. Third, fiscal policy is slow to act and is increasingly an inept instrument for attaining particular economic objectives. This is especially true in a world of high-frequency data. The impression is sometimes given that what has changed, in the 1990s especially, is the greater recognition of the importance of price stability. Nothing could be further from the truth. Economists and policy makers long ago felt that monetary policy was about delivering low and stable inflation rates.