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Efficient Rules for Monetary Policy

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  • Laurence Ball

Abstract

This paper defines an efficient rule for monetary policy as one that minimizes a weighted sum of output variance and inflation variance. It derives several results about the efficiency of alternative rules in a simple macroeconomic model. First, efficient rules can be expressed as 'Taylor rules' in which interest rates respond to output and inflation. But the coefficients in efficient Taylor rules differ from the coefficients that fit actual policy in the United States. Second, inflation targets are efficient. Indeed, the set of efficient rules is equivalent to the set of inflation-target policies with different speeds of adjustment. Finally, nominal-income targets are not merely inefficient, but disastrous: they imply that output and inflation have infinite variances.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5952.

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Date of creation: Mar 1997
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Publication status: published as International Finance, Vol. 2, no. 1 (April 1999): 63-83
Handle: RePEc:nbr:nberwo:5952

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  1. Martin Feldstein & James H. Stock, 1993. "The Use of Monetary Aggregate to Target Nominal GDP," NBER Working Papers 4304, National Bureau of Economic Research, Inc.
  2. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  3. Christiano, Lawrence J & Eichenbaum, Martin & Evans, Charles, 1996. "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 16-34, February.
  4. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1.
  5. Robert E. Hall & N. Gregory Mankiw, 1994. "Nominal Income Targeting," NBER Chapters, in: Monetary Policy, pages 71-94 National Bureau of Economic Research, Inc.
  6. Eric Hansen, 1996. "Price level versus inflation rate targets in an open economy with overlapping wage contracts," Pacific Basin Working Paper Series 96-01, Federal Reserve Bank of San Francisco.
  7. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
  8. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.).
  9. West, Kenneth D, 1986. "Targeting Nominal Income: A Note," Economic Journal, Royal Economic Society, vol. 96(384), pages 1077-83, December.
  10. Glenn Rudebusch, 1995. "What are the lags in monetary policy?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb3.
  11. Matheny, K-J, 1996. "Output Targeting and an Argument for Stabilization Policies," Purdue University Economics Working Papers 1092, Purdue University, Department of Economics.
  12. Taylor, John B., 1985. "What would nominal GNP targetting do to the business cycle?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 22(1), pages 61-84, January.
  13. Bennett T. McCallum, 1993. "Specification and Analysis of a Monetary Policy Rule for Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 11(2), pages 1-45, December.
  14. repec:fth:harver:1418 is not listed on IDEAS
  15. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  16. Frankel, Jeffrey, 1995. "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 318-34, May.
  17. J. Bradford DeLong & Lawrence H. Summers, 1988. "How Does Macroeconomic Policy Affect Output?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(2), pages 433-494.
  18. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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