“I’d like to know why controlling inflation is important and why monetary policy is good at that. Why is that the only appropriate goal for it?”
In the medium term, printing more money just leads to more inflation it doesn’t do anything else. In the short-term it can increase activity – but it only does this by forcing the allocation of resources to be suboptimal and tricking people about the relative value of their sales (as a result the welfare impact of the higher GDP stat is ambiguous).
Furthermore, if we have a central bank that can commit to low inflation, then in the face of a “demand shock” the policy that smooths economic activity and the policy that keeps inflation low is the same!! We need to Bank to be able to commit as there is a “time inconsistency problem”.
This problem is as follows. People form inflation expectations on the basis on the basis of an information set with lagged variables in it, and expectations of current and future variables. Given these expectations, monetary authorities can print money now and push up output, but this will lead to inflation in the future (when people realize that it was just money rolling into the economy, not an increase in actual productive capacity). If the monetary authority has some sort of loss function that is positively related to deviations in output and inflation from their natural rate it will be tempted to do this.
As a result, people will realize this temptation and form expectations on the basis they expect the central bank to do this – which then causes inflation expectations (and thereby price setting, and thereby inflation) to be higher. If the Bank can commit to a path of future interest rates (by committing to a loss function in only inflation for example) then they can anchor inflation expectations without any output cost.
I probably wasn’t very clear – for a better explanation you can just look at the Barro-Gordon model.
“I’m not convinced by the ‘one instrument-one target’ thing. Can I target the money supply and inflation at the same time? It may sound facile to ask, but you’re not preaching to a sophisticated audience, I imagine.”
The growth in the money supply is (in some sense) inflation. They are the same target. We can’t have policy goals with one instrument and two targets – as there is no guidance about what to do when there is a trade-off between the targets. This is ultimately an issue of “credibility” and “accountability” again – it’s not saying that monetary policy only influences one thing in the short-term, it is about making the nature of monetary policy transparent.
“I’d also like to know what you think the appropriate policy response to low growth is”
Depends why we have low growth.
If it is because technology is static and/or population growth has stopped then there is no policy response. I need a market/government failure before I can give a policy response – low growth in itself isn’t a defined failure.
Note: I didn’t cover a lot of this in the article – because I can’t fit it in. Monetary policy is really about anchoring inflation expectations and (in some sense) thereby just making sure that the technical increase in the money stock is sufficient to meet implicit demand in society.