Monetary Policy.

This book represents an impressive collection of a wide range of empirical research on monetary policy. Monetary authorities have multiple objectives which include, but are not limited to, stabilizing employment and prices and fostering economic growth. Their actions in attaining these objectives have powerful impact on the economy. The articles in this book provide new evidence on the timing, magnitude, and channels of these actions.

The volume consists of nine papers by prominent academicians and policy makers. Each paper, except one, is followed by a commentary. The papers address diverse topics. It is sometimes obvious that the authors do not always agree with one another. The extent of divergence and even sharp contradiction, especially in interpretation and conclusion, is revealing. What binds these papers together is a belief that monetary policy is important and hence serious research should be conducted in order to improve its effectiveness.

An interesting question in monetary economics is the amount of information contained in monetary aggregates and how a central bank might use that information. In the first paper in the volume, Martin Feldstein and James Stock use a vector autoregressive model to derive an optimal M2 rule. They argue that the Federal Reserve Bank could use M2 to reduce both the average inflation rate and the volatility in GDP growth. Using a battery of tests for parameter stability, the authors find a stable relationship between nominal GDP and M2. In contrast, the link between nominal GDP and more narrow monetary aggregates are found to be highly unstable.

Robert Hall and Gregory Mankiw argue that nominal income targeting is a reasonably good rule for the conduct of monetary policy. They compare three types of nominal income targets and suggest that the consensus forecast of future nominal income could play a role in preventing the central bank from deviating from its announced target. They use the results from a simulation model to point out that one of the primary benefits of such a policy would be reduced volatility for the price level and the inflation rate. However, whether real economic activity would also be less volatile is unclear from these results. Hall and Mankiw's article leaves room for disagreement, and Kenneth West's commentary does a nice job of pointing out a number of problem areas.

In recent years, there have been numerous suggestions by policy makers and academicians that variables, such as, commodity prices, exchange rates, and interest-rate yield spreads could be useful in conducting monetary policy. Proponents of using such indicators refer to their improved forecasting performance. In his paper, Michael Woodford points out to the irrelevance of reduced-form forecasting regression in this regard and argues that structural econometric models should be used for evaluating various indicators of monetary policy.

It is widely accepted that, in the long run, inflation is determined primarily by monetary policy. However, the short-run behavior of prices is still a subject of intense debate. The next three papers in the volume by Alan Blinder, Laurence Ball, and Michael Bryan and Stephen Cecchetti raises various issues relating to the determination of the price level. Blinder reports on a survey conducted with the help of a group of graduate students at Princeton. In this survey, firms are asked about their behavior as well as their opinion about which particular theory of price adjustment best describes their behavior. An analysis of the responses confirm the presence of sticky prices in the United States. When considering price changes, the survey indicates that the firms are very concerned about coordination issues.

The central bank's effort to reduce inflation often results in high unemployment and low output. The cost of such a policy is often calculated using the sacrifice ratio: the ratio of the loss in output to the reduction in inflation. Ball calculates the sacrifice ratio for sixty-five individual disinflation episodes in the OECD countries. He finds that the ratio is usually smaller in more rapid disinflations. It is also smaller in countries with more flexible wage-setting institutions.

Policy makers and researchers have long searched for the appropriate measure of inflation which would help to distinguish short-term noise from long-term trend. Bryan and Cecchetti address this issue by considering alternative measures of core inflation. Based on the results from a model of asymmetric supply shocks with costly price adjustment, they suggest that the median rate of inflation provide a superior measure of core inflation. They find that, compared to average inflation as well as other measures of core inflation, the median inflation is more correlated with lagged money growth and offers a better forecast of future inflation.

The papers by Anil Kashyap and Jeremy Stein and by Jeffrey Miron, Christina Romer, and David Weil deal with the monetary transmission mechanism. Specifically, they provide alternative perspectives on a recently debated channel of monetary policy - the reduction in bank lending that must accompany a reduction in bank reserves - better known as the lending view of monetary policy. According to this view, when the central bank reduces reserves, it not only raises the interest rate on bonds, but also reduces the supply of bank loans. Kashyap and Stein survey the recent literature on the lending view, examining its theoretical foundation as well as reviewing the empirical evidence.

Miron, Romer, and Weil examine how the importance of the lending channel has evolved over time. However, their study raises more questions than it answers. For instance, their results indicate that the conventional indicators of the lending channel fail to predict the performance of this channel during both the pre- and post-Great depression period.

In a recent paper, Christina and David Romer have identified dates when the FED appeared to have shifted their policy towards reducing the inflation rate. In the last paper in this volume, Matthew Shapiro investigates the causes and effects of this decision. However, his results only indicate the obvious - the FED's decision regarding disinflation is influenced by the outlook for unemployment as well as inflation. Interestingly, Shapiro fails to find any reduction in the inflation rate after the Romer dates. Permanent reduction in the inflation rate is evident only after the Volcker disinflation; while, the disinflation after the 1973 oil crisis turns out to be temporary.

Those readers who approach this volume looking for a single, cohesive treatment of monetary policy will likely be disappointed. The nine selections in the book covers an enormous range of research and theory. A danger in such an endeavor is that the volume may end up scattered and cumulatively incoherent. Thanks to a good editorial job by Gregory Mankiw, this doesn't happen as the selections are tied so strongly to the central theme of monetary policy, ensuring its effectiveness as a policy tool.

This volume, in many ways, raises and indeed explores many intriguing issues faced by the monetary policy makers. The contents of the volume leaves the reader partially satisfied. This may be attributed not to the limitations of the book, but rather to the dilemmas faced by the policy makers. Each article varies in focus and results, but taken in its entirety, the collection is successful in inspiring some of the researchers in this area to undertake further work on these important and exciting topics.

The volume represents an important contribution to our understanding of monetary policy and should appeal to a wide range of audiences well beyond the central bankers and academicians. It is a required reading for any serious student of monetary policy and its role as a stabilization tool.

Abdur R. Chowdhury Marquette University and Johns Hopkins University