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Targeting versus instrument rules for monetary policy

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Author Info
Bennett T. McCallum
Edward Nelson

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Abstract

Svensson (2003) argues strongly that specific targeting rules-first-order optimality conditions for a specific objective function and model-are normatively superior to instrument rules for the conduct of monetary policy. That argument is based largely on four main objections to the latter, plus a claim concerning the relative interest-instrument variability entailed by the two approaches. The present paper considers the four objections in turn and advances arguments that contradict all of them. Then, in the paper's analytical sections, it is demonstrated that the variability claim is incorrect, for a neo-canonical model and also for a variant with one-period-ahead plans used by Svensson, providing that the same decisionmaking errors are relevant under the two alternative approaches. Arguments relating to general targeting rules and actual central bank practice are also included.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2005)
Issue (Month): Sep ()
Pages: 597-612
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Handle: RePEc:fip:fedlrv:y:2005:i:sep:p:597-612:n:v.87no.5

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Keywords: Monetary policy ; Banks and banking; Central;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
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  2. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
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  3. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis. [Downloadable!]
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  4. Levin, Andrew T. & Williams, John C., 2003. "Robust monetary policy with competing reference models," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 945-975, July. [Downloadable!] (restricted)
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  5. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January. [Downloadable!] (restricted)
  6. Michael Woodford, 1999. "Commentary : how should monetary policy be conducted in an era of price stability?," Proceedings, Federal Reserve Bank of Kansas City, pages 277-316. [Downloadable!]
  7. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics. [Downloadable!]
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  8. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June. [Downloadable!] (restricted)
  9. Andrew Levin & Volker Wieland & John C. Williams, 1998. "Robustness of Simple Monetary Policy Rules under Model Uncertainty," NBER Working Papers 6570, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Christopher Allsopp, 2002. "Macroeconomic Policy Rules in Theory and in Practice," Discussion Papers 10, Monetary Policy Committee Unit, Bank of England. [Downloadable!]
  11. Henrik Jensen, 2002. "Targeting Nominal Income Growth or Inflation?," American Economic Review, American Economic Association, vol. 92(4), pages 928-956, September. [Downloadable!]
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  12. McCallum, Bennett T & Nelson, Edward, 2000. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 74-91, Winter.
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  13. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," Levine's Bibliography 506439000000000394, UCLA Department of Economics. [Downloadable!]
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  14. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2002-11, University of Oregon Economics Department, revised 01 Feb 2004. [Downloadable!]
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  15. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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  16. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June. [Downloadable!] (restricted)
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  17. Professor Lars E O Svensson, 2001. "Independent review of the operation of monetary policy in New Zealand," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 64, March. [Downloadable!]
  18. Richard Clarida & Jordi Gali & Mark Gertler, 2001. "Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach," American Economic Review, American Economic Association, vol. 91(2), pages 248-252, May. [Downloadable!] (restricted)
  19. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  20. Svensson, Lars E. O., 1999. "Inflation targeting as a monetary policy rule," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 607-654, June. [Downloadable!] (restricted)
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  21. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, September.
  22. David Longworth & Brian O’Reilly, 2000. "The Monetary Policy Transmission Mechanism and Policy Rules in Canada," Working Papers Central Bank of Chile 72, Central Bank of Chile. [Downloadable!]
  23. Lars E. O. Svensson & Michael Woodford, 2003. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Working Papers 9747, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  24. Bennett T. McCallum & Edward Nelson, 2000. "Timeless Perspectives vs. Discretionary Monetary Policy In Forward-Looking Models," NBER Working Papers 7915, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  25. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June. [Downloadable!] (restricted)
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  26. Dr. Peter Kenning & Hilke Plassmann, 2004. "NeuroEconomics," Experimental 0412005, EconWPA. [Downloadable!]
  27. Denise Côté & Jean-Paul Lam & Ying Liu & Pierre St-Amant, 2002. "The Role of Simple Rules in the Conduct of Canadian Monetary Policy," Bank of Canada Review, Bank of Canada, vol. 2002(Spring), pages 27-35. [Downloadable!]
  28. Cecchetti, Stephen G, 2000. "Making Monetary Policy: Objectives and Rules," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 43-59, Winter.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jim Engle-Warnick & Nurlan Turdaliev, 2006. "An Experimental Test of Taylor-Type Rules with Inexperienced Central Bankers," CIRANO Working Papers 2006s-05, CIRANO. [Downloadable!]
    Other versions:
  2. Edward Nelson, 2008. "Friedman and Taylor on monetary policy rules: a comparison," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 95-116. [Downloadable!]
  3. Lars E O Svensson, 2005. "Monetary Policy with Judgment: Forecast Targeting," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May. [Downloadable!]
    Other versions:
  4. Miguel Casares, 2006. "A close look at model-dependent monetary policy design," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 451-470. [Downloadable!]
  5. Chengsi Zhang & Denise R. Osborn & Dong Heon Kim, 2006. "The New Keynesian Phillips Curve: from Sticky Inflation to Sticky Prices," The School of Economics Discussion Paper Series 0631, Economics, The University of Manchester. [Downloadable!]
    Other versions:
  6. Peter Bofinger & Eric Mayer, 2006. "The Svensson versus McCallum and Nelson Controversy Revisited in the BMW Framework," Discussion Papers of DIW Berlin 585, DIW Berlin, German Institute for Economic Research. [Downloadable!]
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