What Monetary Policy Can Do

Monetary policy has the unique ability to determine inflation over time. That ability is independent of whether or not there is a reliable Phillips curve correlation. Moreover, it remains true in a world with interest on reserves and large bank reserve account balances. The effect of monetary policy on real activity, on the other hand, is likely to be transitory, which suggests caution in trying to use monetary policy to have significant real effects over the medium term. Even more caution should apply, given the state of our understanding, to the notion that monetary policy should respond to signals of incipient financial instability, an idea that has received considerable attention since the crisis. Conducting monetary policy to achieve low and stable inflation over time, without doing damage to real activity, is hard enough.

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