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Money and Inflation

The 20th century has become the breakpoint in the theoretical and practical research of inflation, money, and the impact of monetary policies on macroeconomic growth. Since the middle of the 1970s the relationships between inflation, money growth, and unemployment in the American economy have changed dramatically: inflation was less volatile, unemployment was low, and the state seemed careless in regard to the content and effects of its monetary policies.

However, at the edge of the 21st century, with the growing oil and currency crisis, the United States has finally realized the importance of sound monetary policies as the instruments for containing inflation and controlling money growth. In the center of the new economic turmoil, inflation, monetary policy, and monetary credibility have formed an essential triangle of the state’s macroeconomic needs, of which monetary credibility was and is the critical element, driving positive consumer expectations and changing the inflation / money growth ratio in the American and international currency markets.

Literature review Under the growing financial pressures, researchers pay more and more attention to the role of the monetary policy in anti-inflation campaigns. While the causes of inflation are still unclear, economists are coming to realize the importance of monetary policies as the

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instruments driving consumer credibility, and as a result, positive economic expectations. “Academic economists attempting to understand the dynamics of inflation pursue a particular strategy. They start by studying the dynamic characteristics of inflation data, as well as of related variables.

[…] In this context, the economist’s model must not only do a good job in capturing the behavior of the private economy, but it must also explain the behavior of monetary authorities” (Christiano & Fitzgerald, 2003). That is why researchers pay extensive attention to the ways monetary policies can impact inflation in short- and long-term periods. In their research, Christiano and Fitzgerald (2003) investigate the changes in the U. S. monetary policies in the 20th century. The researchers have chosen a new and somewhat surprising angle, where inflation dynamics in the U.

S. is reviewed through the prism of the American authorities’ commitment to sound monetary policies. They review “various theories about inflation, but put special focus on the institutions’ view: theories that focus on lack of commitment in monetary policy as the culprit behind bad inflation outcomes” (Christiano & Fitzgerald, 2003). Christiano and Fitzgerald (2003) have traced the inflation dynamics in the first half of the 20th century, when government commitment to monetary control was higher than in the last decade.

In the light of the negative inflation – unemployment shifts that took place at the beginning of the 21st century, institutional commitment to sound monetary policies could have become an effective instrument containing inflation and driving economic growth; but why are monetary policies so important? The role and importance of monetary policies is two-fold: first, they improve credibility of the national banking network, and the credibility of the national monetary policy itself. Second, monetary policies are the effective instruments that can be used to restrain inflation in the face of economic crises.

These assumptions are further explored by Anna Schwartz (2007). Schwartz (2007) suggests that “historically, the Fed has not regarded the balance of payments as its responsibility. The role of the Fed is limited to its core responsibility: deliver price stability. By performing this role, it will assure the soundness of the dollar, maintain the attraction of the United States as a desirable place for investment, and facilitate the global adjustment of imbalances”. As a result, the Fed has been distancing itself from the need to address the threatening inflationary trends.

To maintain price stability does not necessarily mean to avoid inflation; in reality, inflation requires developing and implementing a whole set of monetary policies – the policies that would create an image of the Fed as the institution that promotes public interests and works for the benefit of the whole nation. Schwartz (2007) concludes that the Fed has already adopted inflation targeting as the central element of the anti-inflationary monetary policies; unfortunately, it has not yet come to realize the need for publicity.

“Whether or not the Fed operates as an inflation targeter, it should certainly improve its communication with the public” (Schwartz, 2007). In other words, the combination of the sound monetary policy, commitment, and publicity are the prerequisites of stability in the U. S. economy as a whole. Ferguson (2006) seems to continue Schwartz’s argument regarding the role of monetary policy as the anti-inflationary instrument. In Ferguson’s (2006) view, monetary policies are not only the instruments that may help minimize the consequences of inflation; these are the reliable drivers of monetary credibility and as a result, economic growth.

In distinction from Schwartz (2007), Ferguson (2006) uses a broader perspective for the analysis of money-inflation trends in the U. S. economy. “Low and stable inflation must start with sound policy – that is, policy that keeps output near potential and offsets shocks to supply and demand appropriately. But beyond that, common intuition and numerous academic journals suggest that credibility can greatly enhance the virtues of sound policy” (Ferguson, 2006).

In general terms, credibility can be defined as “the perception in the private sector that central bans will do what it takes to keep inflation under control” (Ferguson, 2006), and this credibility is likely to play the critical role in our future attempts to fight inflation. Monetary credibility is the foundation of any monetary policy’s long-term success, and when combined with state’s commitment to monetary policies and inflation targeting, these factors can keep our inflation expectations contained in the long run.

Conclusion None of the three articles provides information on whether monetary policies can be harmful, and whether and how they can prevent the state from fighting inflation quickly and effectively. Beyond the mere commitment to monetary policies as such, the state is required to review its previous and current economic attempts, and their impact on the quality and pace of various inflationary trends. What kind of monetary policy is the best for fighting inflation?

What should the state do when trying to contain inflationary expectations? How should the state work to guarantee that its financial institutions and authorities promote effective and reliable monetary mechanisms that are appropriate in the current economic conditions? These questions remain unanswered. It is critical that future research pays special attention to the way monetary policies may change inflation expectations, when inflation outcomes are negative.

Moreover, researchers should address the issue of publicity as a reliable means of regulating inflation / money ratios in the U. S. economy and in the world. References Christiano, L. J. & Fitzgerald, C. (2003). Inflation and monetary policy in the twentieth century. Economic Perspectives, 10: 22-45. Ferguson, R. W. (2006). Monetary credibility, inflation, and economic growth. Cato Journal, 26 (2): 223-230. Schwartz, A. J. (2007). The role of monetary policy in the face of crisis. Cato Journal, 27 (2): 157-163.

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