Theoretical Foundations of the Practice of Modern Monetary Policy

This chapter briefly reviews five theoretical developments that guide the modern practice of central banks in their pursuit of the monetary stability mandate. Specifically, these five theoretical developments, when considered together, suggest that central banks should conduct monetary policy by following a credible rule that aims for a low and stable inflation environment. A credible rule for the central bank's conduct of monetary policy helps manage public expectations that the central bank will use monetary policy to achieve only what it does best, that is, ensure long-term price stability, as opposed to trying to push unemployment below the natural rate.