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Cover -- Half Title -- Title Page -- Copyright Page -- Original Title Page -- Original Copyright Page -- Table of Contents -- List of Tables -- List of Figures -- Notation -- Preface -- Part I Theory -- 1 A New Keynesian framework for macroeconomic policy -- 1.1 An overview of the ideas in this book -- 1.1.1 New Keynesian financial policy: objectives and instruments -- 1.1.2 The labour market -- 1.1.3 An exchange-rate intermediate target -- 1.1.4 Expectations formation -- 1.1.5 Small models, large models, and control theory -- 1.2 Three policy frameworks compared -- 1.2.1 The Keynes-Bretton Woods framework and its demise -- 1.2.2 The monetarist framework and its demise -- 1.2.3 The New Keynesian framework -- 1.3 Financial policy explained -- 1.3.1 Money GDP as a financial target -- 1.3.2 National wealth as a financial target -- 1.3.3 The rate of interest as the instrument of monetary control -- 1.3.4 The rate of tax as the instrument of fiscal control -- 1.3.5 'Instrument-target emphasis': the linkages of financial targets to financial instruments -- 1.4 Wage fixing and its implications for financial policy -- 1.5 Exchange-rate management -- 1.5.1 The case for foreign exchange rate targeting -- 1.5.2 The foreign exchange rate as an intermediate target -- 1.6 Expectations -- 1.7 The form of control -- 1.8 International aspects of policy rules -- 1.9 Outline of subsequent chapters -- 2 The linkages between financial weapons and financial targets: a comparative static analysis -- 2.1 Linkages and emphasis -- 2.2 The model of a closed economy -- 2.2.1 Assumptions -- 2.2.2 Basic equations -- 2.2.3 Comparative statics -- 2.2.4 Comparative advantage and emphasis -- 2.3 The control of inflation and wealth in a closed economy -- 2.4 The availability of free lunches -- 2.5 The open economy -- 2.6 Conclusion -- 3 The dynamics of price stabilization.

Modern economic theory gives an important role to expectations as an influence on outcomes. This paper reviews evidence on how well measures of expectations conform to outcomes. It confirms earlier results that measures taken from financial markets perform poorly as predictors of outcomes. Looking at the individual responses to the Confederation of British Industry's Industrial Trends Survey, it does find, however, that there are significant correlations between expected and realised outcomes of wages, prices, costs orders and employment. It also finds some evidence that actual prices reflect expected future prices, but with a coefficient much lower than economic theory predicts. There is evidence that forecast errors are explained by past forecasts, as well as revisions to the economic outlook, casting doubt on the idea that firms' forecasts make the best use of the information available at the time. The paper concludes by observing that, while expectations are undoubtedly important, economists need to build on work looking at how they are derived instead of simply assuming they are rational.

Over the past twenty years the expansion of the British economy has been supported by growth in the financial services industry. With the onset of the financial crisis it seems most unlikely that the financial services industry can, in the future, act as the sort of motor of growth that it had done in the past. This commentary provides an overview of the role of the financial services sector in the economy over the past twenty years and assesses likely developments in the future. It first assesses the contribution of the sector to the economy and then considers the issues surrounding its likely shape in the future.

One might expect bank borrowing to rise during a recession as businesses seek extra credit to tide them over; the data have to be seen in this context. Indeed, in the 1990s recession lending by banks adjusted for inflation continued to rise (with one interruption) until almost the end of the recession. However, recently lending to UK businesses has been declining, as figure 1 shows. This indicates lending by UK and foreign banks to non-bank businesses with data available up to the end of the third quarter of 2008 after deflating with the GDP deflator.

The sharp rise in the real price of oil has taken it up to or above the levels seen after the second oil crisis of the late 1970s (depending on the currency considered) and has been, to say the least, somewhat disruptive to a world which had anticipated relatively cheap oil, probably for the indefinite future. At the very least, it is hard to imagine that some major consuming countries would have saved as little as they did, had they given proper attention to oil's status as an exhaustible resource. In this commentary the current situation is viewed from that perspective. The short-term impact of high oil prices is discussed on pp. 34–8.

September brought the United Kingdom its first mass market bank run. Although there had been bank runs in the nineteenth century, with the last in 1866, very few people then had bank accounts so the runs were not in any sense comparable with what happened to Northern Rock, which showed a failure of mass retail banking.

The July interest rate increase has taken the Bank of England's Base Rate to the highest value for six years. In figure 1 we show the forward estimates for the nominal short-term interest rate taken from the Bank of England's yield curve tables for both government debt and liabilities of commercial banks. These are in effect market forecasts of the short-term rate produced in the past. The graph shows that the market has been taken somewhat by surprise by rising short-term interest rates. Two years ago the market was forecasting a rate of around 4 per cent per annum for July 2007. Nor were the probabilities the market gave to an interest rate of 5.75 per cent per annum very high. Twelve months ago the market in financial options implied that the chance of the rate exceeding 5.66 per cent per annum was only 15 per cent. Even in January of this year the chance of it reaching its current level or higher was put at less than 25 per cent. The National Institute cannot claim a substantially better record at forecasting interest rates. We normally use market expectations, as calculated from the yield curve, to provide exogenous forecasts as input into our model in the short term.