Chapter 21 Mishkin Summary 09/21/2013
There are highlights in the Mishkin text you should read over in addition to the below summary points.
1. A nominal anchor is a key element in monetary policy strategies. It helps promote price stability by
tying down inflation expectations and limiting the time consistency problem, in which monetary
policymakers conduct monetary policy in a discretionary way that produces poor longrun outcomes.
2. Exchangerate targeting has the following advantages: (1) it directly keeps inflation under control by
tying the inflation rate for internationally traded goods to that found in the anchor country to whom its
currency is pegged; (2) it provides an automatic rule for the conduct of monetary policy that helps
mitigate the timeconsistency problem; and (3) it has the advantage of simplicity and clarity. Exchange
rate targeting also has serious disadvantages: (1) it results in a loss of independent monetary policy
and increases the exposure of the economy to shocks from the anchor country; (2) it leaves the
currency open to speculative attacks; and (3) it can weaken the accountability of policymakers because
the exchangerate signal is lost. Two strategies that make it less likely that the exchange rate regime
will break down are currency boards, in which the central bank stands ready to automatically exchange
domestic for foreign currency at a fixed rate, and dollarization, in which a sound currency like the U.S.
dollar is adopted as the country’s money.
3. Monetary targeting has two main advantages: It enables a central bank to adjust its monetary policy
to cope with domestic considerations, and information on whether the central bank is achieving its
target is known almost immediately. On the other hand, monetary targeting suffers from the
disadvantage that it works well only if there is a reliable rel