Discuss the change of the design of monetary policy over time

Question

What will be an ideal response?

Answer 1

Traditionally, the design of monetary policy was focused on nominal money growth. But, because of the poor relation between inflation and nominal money growth, this approach was abandoned by most central banks. Central banks now typically focus on an inflation rate target rather than a nominal money growth rate target. And they think about monetary policy in terms of determining the nominal interest rate rather than determining the rate of nominal money growth. The Taylor rule gives a useful way of thinking about the choice of the nominal interest rate. The rule states that the central bank should move its interest rate in response to two main factors: the deviation of the inflation rate from the target rate of inflation, and the deviation of the unemployment rate from the natural rate of unemployment. A central bank that follows this rule will stabilize activity and achieve its target inflation rate in the medium run.