Introduction

The chapters in this volume are the outcome of a conference held in Cambridge in March 2010. The title of the conference was ‘New instruments of monetary policy’. Its purpose was to bring together economists from academia, financial markets and central banks to discuss some of the challenges that arose from both the financial crisis itself and the response to that crisis. Many of the assumptions that underpin mainstream (core) macroeconomic models have been challenged as a result of the traumatic events of the past three years. In particular, it became clear that the modern, micro-founded, form of macroeconomic model failed to allow adequately for the financial sector.

This failure, in part, reflected the belief that one could safely separate issues concerned with financial stability from the conduct of macroeconomic policy: macroeconomic policy, and in particular monetary policy, should be devoted to the stabilisation of inflation and output, and the short-term nominal interest rate used as the instrument of policy. Although it is well known that such a policy will be problematic when nominal interest rates are close to the zero interest rate floor, in practice it seemed that policy was successful in keeping the economy away from this region. The long road to price stability in the UK led down a number of cul-de-sacs, from monetary targets, shadow exchange rate targets, explicit exchange rate targeting and inflation targeting – without and then with operational central bank independence – and seemed to have arrived at its destination.