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Monetary Policy, Interest Rate Rules, and Inflation Targeting: Some Basic Equivalences

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  • Carlos Végh

Abstract

Policymakers increasingly view short-term nominal interest rates as the main instrument of monetary policy, often in conjunction with some inflation target. Interest rates on short-term indexed government debt (i.e., a real interest rate) have also been used as policy instruments. To understand the pros and cons of different policy rules and instruments, this paper derives some basic equivalences among different policy rules. It is shown that , under certain conditions, the following three rules are exactly equivalent: (i) a "k-percent" money growth rule; (ii) a nominal interest rate rule combined with an inflation target, and (iii) a real interest rate rule combined with an inflation target. These policy rules, however, become increasingly complex: the first rule requires no feedback mechanism; the second rule requires responding to the inflation gap; while the third rule involves responding to both the inflation gap and the output gap. It is also shown that money growth rules and nominal interest rate rules which respond to the output gap may deliver better outcomes.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 32.

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Date of creation: Apr 1998
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Handle: RePEc:chb:bcchwp:32

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  1. Bruno, Michael, 1993. "Crisis, Stabilization, and Economic Reform: Therapy by Consensus," OUP Catalogue, Oxford University Press, number 9780198286639.
  2. Sebastian Edwards, 1991. "Stabilization and Liberalization Policies in Central and Eastern Europe: Lessons From Latin America," NBER Working Papers 3816, National Bureau of Economic Research, Inc.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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Cited by:
  1. Schabert, Andreas, 2005. "Money supply and the implementation of interest rate targets," Working Paper Series 0483, European Central Bank.
  2. Andreas Schabert, . "On the Equivalence of Money Growth and Interest Rate Policy," Working Papers 2003_6, Business School - Economics, University of Glasgow, revised Apr 2003.
  3. Chin, Chi-Ting & Guo, Jang-Ting & Lai, Ching-Chong, 2009. "Macroeconomic (in)stability under real interest rate targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1631-1638, September.
  4. Nejla Adanur Aklan & Mehmet Nargelecekenler, 2008. "Taylor Rule in Practice: Evidence from Turkey," International Advances in Economic Research, Springer, vol. 14(2), pages 156-166, May.
  5. Andreas Schabert, 2005. "Money Supply and the Implementation of Interest Rate Targets," Tinbergen Institute Discussion Papers 05-059/2, Tinbergen Institute.
  6. Erdin MALOKU, 2011. "Role of Central Bank in the Establishment and the Development of Financial System in Post-War Kosovo," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 1(5), pages 14, August.
  7. Horacio A. Aguirre, 2011. "On the “Science” of Monetary Policy: Methodological Notes," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(64), pages 83-115, October -.
  8. Schabert, Andreas, 2009. "Money supply, macroeconomic stability, and the implementation of interest rate targets," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 333-344, June.
  9. Shigeto Kitano, 2007. "Capital Controls, Public Debt and Currency Crises," Journal of Economics, Springer, vol. 90(2), pages 117-142, March.

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