A heated debate has arisen over the policy ineffectiveness proposition associate with the work of Lucas, Sargent, and Wallace. It postulates that anticipated aggregate demand policy will have no effect on business-cycle fluctuations, so that one deterministic, feedback policy rule is as good as any other from the point of view of stabilizing the economy. This paper develops a methodology for empirically analyzing rational-expectations models displaying this neutrality result and then applies it to the important question of whether anticipated monetary policy matters to the business cycle.

This short paper argues that the view that monetary policy is ineffective during financial crises is not only wrong, but may promote policy inaction in the face of a severe contractionary shock. To the contrary, monetary policy is more potent during financial crises because aggressive monetary policy easing can make adverse feedback loops less likely. The fact that monetary policy is more potent than during normal times provides a rationale for a risk-management approach to counter the contractionary effects from financial crises, in which monetary policy is far less inertial than would otherwise be typical -not only by moving decisively through conventional or nonconventional means to reduce downside risks from the financial disruption, but also in being prepared to quickly take back some of that insurance in response to a recovery in financial markets or an upward shift in inflation risks.

This paper outlines what inflation targeting involves for emerging market/transition countries and discusses the advantages and disadvantages of this monetary policy strategy. The discussion suggests that although inflation targeting is not a panacea and may not be appropriate for many emerging market countries, it can be a highly useful monetary policy strategy in a number of them.