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Design flaws in the construction of monetary conditions indices? A cautionary note

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  • Alfred Guender
  • Troy Matheson

Abstract

Monetary conditions indices featured prominently as instrument variables or operating targets, particularly in the inflation-targeting countries during the 1990s. In this paper, we show that conventional monetary conditions indices are potentially mis-specified. Under a regime of strict inflation targeting, conventional MCIs are unreliable indicator variables or operating targets if there is a direct exchange rate effect on the rate of inflation in the Phillips Curve. We also point to the limitations of a standard MCI under strict inflation targeting. The policymaker can circumvent these limitations by redefining the inflation target. Nevertheless, from a general perspective the usefulness of MCIs in the conduct of monetary policy is doubtful in view of their model-specific nature.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal New Zealand Economic Papers.

Volume (Year): 36 (2002)
Issue (Month): 2 ()
Pages: 209-215

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Handle: RePEc:taf:nzecpp:v:36:y:2002:i:2:p:209-215

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Related research

Keywords: Monetary Conditions Index (MCI); Strict Inflation-Targeting; Direct Exchange Rate Channel; Misspecification;

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Cited by:
  1. Buckle, Robert A. & Kim, Kunhong & Kirkham, Heather & McLellan, Nathan & Sharma, Jarad, 2007. "A structural VAR business cycle model for a volatile small open economy," Economic Modelling, Elsevier, vol. 24(6), pages 990-1017, November.

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