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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.

Suggested Citation

  • Alfred Guender & Troy Matheson, 2002. "Design flaws in the construction of monetary conditions indices? A cautionary note," New Zealand Economic Papers, Taylor & Francis Journals, vol. 36(2), pages 209-215.
    • Handle: RePEc:taf:nzecpp:v:36:y:2002:i:2:p:209-215
    DOI: 10.1080/00779950209544371
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    1. Tim Hampton, 2001. "How much do import price shocks matter for consumer prices?," Reserve Bank of New Zealand Discussion Paper Series DP2001/06, Reserve Bank of New Zealand.
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