Commentary: How Should Monetary Policy Respond to Shocks While Maintaining Long-Run Price Stability? —Conceptual Issues

I find John Taylor’s review of the mistakes of the past very inspiring, but I am not willing to write off time-consistency problems as easily as he does. In some European countries, strong labor movements seem to have imposed unrealistically high employment goals on fiscal and monetary policy. These movements seem to have done their best to block any reform and deregulation of labor markets and wage setting, which might lower the natural rate of unemployment, and have instead preferred to assign responsibility for lowering unemployment to fiscal and monetary policy, even though these cannot deliver. John Taylor believes that time-consistency problems can easily be fixed with legislation or other social arrangements. As we all know, there is a very strong case, both theoretically and empirically, for a monetary policy arrangement with a legislated price stability mandate, operational (instrument-) independence, and accountability for the central bank. (See Fischer, 1994.) In practice, though, the politics of such reforms are far from easy. Only recently have a number of countries undertaken such reforms, but reforms are still blocked in some countries,