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Efficient Rules for Monetary Policy

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  • Ball, Laurence

Abstract

This paper defines an efficient rule for monetary policy as one that minimizes a weighted sum of output variance and inflation variance. It derives several results about the efficiency of alternative rules in a simple macroeconomic model. First, efficient rules can be expressed as "Taylor rules" in which interest rates respond to output and inflation. But the coefficients in efficient Taylor rules differ from the coefficients that fit actual policy in the United States. Second, inflation targets are efficient. Indeed, the set of efficient rules is equivalent to the set of inflation-target policies with different speeds of adjustment. Finally, nominal-income targets are highly inefficient: they create great volatility in both inflation and output. Copyright 1999 by Blackwell Publishers Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 2 (1999)
Issue (Month): 1 (April)
Pages: 63-83

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Handle: RePEc:bla:intfin:v:2:y:1999:i:1:p:63-83

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  1. Taylor, John B., 1985. "What would nominal GNP targetting do to the business cycle?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 61-84, January.
  2. J. Bradford DeLong & Lawrence H. Summers, 1988. "How Does Macroeconomic Policy Affect Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(2), pages 433-494.
  3. Matheny, K-J, 1996. "Output Targeting and an Argument for Stabilization Policies," Purdue University Economics Working Papers 1092, Purdue University, Department of Economics.
  4. Svensson, Lars E O, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," CEPR Discussion Papers 1511, C.E.P.R. Discussion Papers.
  5. Martin Feldstein & James H. Stock, 1993. "The Use of Monetary Aggregate to Target Nominal GDP," NBER Working Papers 4304, National Bureau of Economic Research, Inc.
  6. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  7. Frankel, Jeffrey, 1995. "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 318-34, May.
  8. Kenneth D. West, 1986. "Targeting Nominal Income: A Note," NBER Working Papers 1835, National Bureau of Economic Research, Inc.
  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
  11. Bennett T. McCallum, 1993. "Specification and Analysis of a Monetary Policy Rule for Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 11(2), pages 1-45, December.
  12. Henderson, Dale W. & McKibbin, Warwick J., 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 221-317, December.
  13. Hall, R.E. & Mankiw, N.G., 1993. "Nominal Income Targeting," Harvard Institute of Economic Research Working Papers 1650, Harvard - Institute of Economic Research.
  14. Eric Hansen, 1996. "Price level versus inflation rate targets in an open economy with overlapping wage contracts," Pacific Basin Working Paper Series 96-01, Federal Reserve Bank of San Francisco.
  15. Glenn Rudebusch, 1995. "What are the lags in monetary policy?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb3.
  16. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, octubre-d.
  17. repec:fth:harver:1418 is not listed on IDEAS
  18. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
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