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Alternative Monetary Policy Rules for the Philippines

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  • Francisco Dakila, Jr.

    (Department of Economic Research, Bangko Sentral ng Pilipinas)

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    Abstract

    A theoretical basis for modifying the currently popular nominal feedback rules is provided for the conduct of monetary policy so that they react to the forecasted inflation rate, instead of to current or past actual inflation. It is shown that such a modification reduces the risk of economic instability arising from the adoption of a nominal feedback rule, and thus produces results that are closer to the optimal solution. It is furthermore shown that given rational expectations, a forward-looking rule, and a money demand function that is not completely interest-inelastic, the optimal monetary policy entails some degree of policy activism. Friedman s constant money growth rule is therefore shown to be optimal only in a special case, i.e, when the money demand function is completely insensitive to the rate of interest. Empirical simulations are conducted, which support the view that forward-looking nominal instrument rules provide better performance in terms of keeping inflation closer to the targeted level. The simulations also provide a measure of the optimal degree of activism for monetary policy, as well as of the optimal forecasting horizon.

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    File URL: http://pre.econ.upd.edu.ph/index.php/pre/article/view/46/549
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    Bibliographic Info

    Article provided by University of the Philippines School of Economics and Philippine Economic Society in its journal Philippine Review of Economics.

    Volume (Year): 38 (2001)
    Issue (Month): 2 (December)
    Pages: 1-36

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    Handle: RePEc:phs:prejrn:v:38:y:2001:i:2:p:1-36

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    Postal: Diliman, Quezon City 1101
    Phone: 927-9686
    Web page: http://www.econ.upd.edu.ph/
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    Related research

    Keywords: monetary policy; inflation targeting;

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    References

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    1. Barro, Robert J, 1978. "Unanticipated Money, Output, and the Price Level in the United States," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 549-80, August.
    2. Michael J. Dueker & Andreas M. Fischer, 1998. "A guide to nominal feedback rules and their use for monetary policy," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 55-63.
    3. Fair, Ray C, 1978. "A Criticism of One Class of Macroeconomic Models with Rational Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(4), pages 411-17, November.
    4. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    5. George A. Kahn & Klara Parrish, 1998. "Conducting monetary policy with inflation targets," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 5-32.
    6. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
    7. Mervyn Allister King, 1998. "The Inflation Target Five Years On," FMG Special Papers sp99, Financial Markets Group.
    8. Sargent, Thomas J & Wallace, Neil, 1973. "The Stability of Models of Money and Growth with Perfect Foresight," Econometrica, Econometric Society, vol. 41(6), pages 1043-48, November.
    9. Jeffrey A. Frankel, 1995. "Financial Markets and Monetary Policy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061740, January.
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