Economics Essay Example | Topics and Well Written Essays - 1750 words - 1

Economics - Essay Example The main reason for the differences coming short may so be given by the treasury was the previous failings of monetary policy. In their description of the new monetary framework of October 1999, the principal argument was that previously there had been that numerous shortcomings in the design and conduct of monetary policy. Objectives were often inappropriate or unclear, while decisions were often poorly coordinated with fiscal policy or were made too late to prevent inflationary pressures from building. Roles and responsibilities were also ill-defined, creating the impression that policy decisions could be based on short-term political considerations. A lack of transparency hindered accountability and meant that policy-makers were unable to build credibility (Balls, & ODonnell, 2002). Given that the Treasury was conducting both monetary and fiscal policy prior to giving independence to the Bank, this is a remarkable statement. It seems to be either a vote of no confidence in the Treasury, or in the incoming government. It was argued that previous governments had often accompanied an apparently tough budget with an interest rate cut, only to raise interest rates again shortly afterwards, when the budget proved more inflationary than expected. As a result, they proposed that a test of fiscal policy was whether an independent Bank would change interest rates following a budget. Their finding under the new monetary policy arrangements was that interest rate changes did not seem related to the previous budget (Goodhart, 2006). A possible test of what type of policy the Bank is pursuing may be possible when the Bank is faced by a supply shock. Interest rates control inflation through their effect on aggregate demand. Since a positive aggregate demand shock raises demand and inflation, the correct monetary policy response would be to offset the increase in aggregate demand by higher interest rates. In contrast, a negative supply shock- say an oil price increase,