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Mishkin discusses 7 Guiding Principles that Central Banks should follow. 1) Price stability provides
substantial benefits and Central Bankers should always keep in mind during decision-making. It is
the nominal anchor to keep central banks on course, and lowers uncertainty about prices and
future PL. With price stability outcomes have longer expansions with fewer and shorter recessions.
The Great Moderation had lower price stability and high economic average over time. It lowers
distortion in price allocation system such as the tax system and inflation interaction; the economy is
more efficient and has fewer false signals in the economy. Price stability also means a low and
stable inflation rate which prevents over-investment (high inflation leads to this). Lastly, price
stability creates international competition with the basic idea of maintaining a competitive position
so if others have stable prices, so should the U.S. 2) Fiscal policy should be aligned with monetary
policy. Irresponsible FP may make it more difficult for MP authorities to pursue price stability.
Large government debt puts pressure on MP to increase money growth and inflation; Restraining
deficit financing aligns FP with MP. 3) Time inconsistency is a serious problem to be avoided. Short
run trade off of unemployment and inflation yet poor long run outcomes: expansionary policy shifts
wage and price expectations so no long run economic growth and this policy will lead to higher
inflation in the long run. 4) Monetary Policy should be forward looking. There are long lags in the
economy and if you wait until an undesired outcome like inflation to hit then policy actions are
more likely to be counterproductive. If expected inflation is to rise then they should act quickly; MP
takes about 2 years to affect inflation. Increase in expected inflation then Fed should increase
interest rates which would put downward pressure on prices. 5) Accountability is a basic principle
of democracy. Policymakers should be held accountable to promote efficiency in government. 6)
Monetary Policy should be concerned about output as well as price fluctuations. Do not become
Dzinflation nuttersdz ȂMervyn King 1997. 7) The most serious economic downturns are associated
with financial instability

1. Implications for the role of the Central Bank

1) Price stability should be overriding, long-run goal of monetary policy
2) An explicit nominal anchor should be adopted
3) A central bank should be goal dependent
4) A central bank should be instrument dependent
5) A central bank should be accountable
6) A central bank should stress transparency and communication
7) A central bank should also have the goal of financial stability

2. What should the Fed do?

1) Continue to strengthen the Fedǯs transparency (stems from absence of nominal
anchor) and accountability
2) Advocate a change in its mandate to put price stability as the overriding, long-run
goal of MP
3) Price stability goal should be made explicit, with a numerical long-run inflation goal
4) Produce DzInflation Reportdz that clearly explains its strategy for MP and how well it
has been doing in achieving its announced inflation goal