Instrument Versus Target Rules As Specifications of Optimal Monetary Policy: What are the Issues, If Any?
AbstractOne issue in the literature on monetary policy in New Keynesian models has been the relative merits of instrument versus target rules. This paper focuses on optimal instrument and target rules within three workhorse models in the literature: IS-LM, AS-AD and the New Keynesian model. The focus on optimal rules enables us to exploit the equivalence among alternative expressions of optimal policies for a given information set. We find that in the AD-AS model, characterized by the presence of observable information variables and unobservable target variables, an optimal explicit instrument rule, a combination policy, and a target rule produce identical outcomes for the target variables. In the New Keynesian model, the optimal explicit instrument rule achieves the same stabilization results as the globally optimal target rule. However, the latter approach provides a more direct rationale for introducing inertia into policymaking. This seems to be the key advantage of the target rule approach. Along other dimensions such as robustness and transparency, target rules offer no clear advantages over optimal instrument rules.
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Bibliographic InfoPaper provided by University of Canterbury, Department of Economics and Finance in its series Working Papers in Economics with number 11/20.
Length: 35 pages
Date of creation: 01 Feb 2011
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Find related papers by JEL classification:
- E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-05-14 (All new papers)
- NEP-CBA-2011-05-14 (Central Banking)
- NEP-MAC-2011-05-14 (Macroeconomics)
- NEP-MON-2011-05-14 (Monetary Economics)
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