1 How Did We Get Here ?

The past three decades have seen an extraordinary transformation in the conduct of monetary policy. In the 1970s, inflation had risen to very high levels, with most countries, including the United States, experiencing inflation rates in the double digits. Today, almost all nations in the world are in a low inflation environment. Of 223 countries, 193 currently have annual inflation rates less than or equal to 10 percent, while 149 have annual inflation rates less than or equal to 5 percent.1 Why and how has the strategy of the conduct of monetary policy changed such that it has become so successful in taming inflation? The answer provided in the following chapters is that monetary authorities and governments in almost all countries of the world have come to accept the following ideas: 1) there is no long-run trade-o¤ between output (employment) and inflation; 2) expectations are critical to monetary policy outcomes; 3) inflation has high costs; 4) monetary policy is subject to the time-inconsistency problem; 5) central bank independence is needed to produce successful monetary policy; and 6) a strong nominal anchor is the key to producing good monetary policy outcomes. But this list, which central bankers now subscribe to, is not where monetary policymakers started. In the 1960s, central bankers had a very di¤erent world view, which produced very bad monetary policy outcomes.