Mervyn King gave a useful speech in 2005 on Monetary Policy (what else).
He proposes 3 very important ideas for monetary policy:
1. Expectations are fundamental to effectiveness of monetary policy
2. Strategy of policy is more important that monthly decisions on interest rates
3. Central Banks should be aware of Heuristics while making policies.
I like the way he explains the expectations using Maradona. He says the first goal he scores in 1986 world cup was:
an exercise of the old “mystery and mystique” approach to central banking. His action was unexpected, time-inconsistent and against the rules. He was lucky to get away with it
However, his second goal was vintage Monetary Policy stuff and shows the power of expectations.
Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal. The truly remarkable thing, however, is that, Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.
What is the similarity between the goal and the monetary policy? Simple, like Maradona was able to achieve the goal by simply moving straight, the Central Banks are able to achieve their goals by not making many changes in the rates and letting expectations achieve the goal. The markets expect interest rates to move up or down and this dictates the course of the economy or the goal.
This does not mean that markets does the work but the way Central banks shape expectations. He also adds that however, just like Maradona can’t score a goal every-time by running in a straight line; a Central bank cannot simply let economy run on course without changing interest rates.
A very useful speech. Also read the way he explains heuristics using cricket as an analogy.