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Efficient rules for monetary policy

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This paper defines an efficient rule for monetary policy as one that minimises 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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Paper provided by Reserve Bank of New Zealand in its series Reserve Bank of New Zealand Discussion Paper Series with number G97/3.

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Length: 22p
Date of creation: Jan 1997
Date of revision:
Handle: RePEc:nzb:nzbdps:1997/03

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  1. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
  2. Laurence Ball, 1993. "What Determines the Sacrifice Ratio?," NBER Working Papers 4306, National Bureau of Economic Research, Inc.
  3. 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.
  4. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  5. 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.
  6. 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.
  7. Robert E. Hall & N. Gregory Mankiw, 1993. "Nominal Income Targeting," NBER Working Papers 4439, National Bureau of Economic Research, Inc.
  8. Bennett T. McCallum, 1993. "Specification and Analysis of a Monetary Policy Rule for Japan," NBER Working Papers 4449, National Bureau of Economic Research, Inc.
  9. repec:fth:harver:1418 is not listed on IDEAS
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
  11. 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.
  12. Kenneth D. West, 1986. "Targeting Nominal Income: A Note," NBER Working Papers 1835, National Bureau of Economic Research, Inc.
  13. Glenn Rudebusch, 1995. "What are the lags in monetary policy?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb3.
  14. 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.).
  15. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, July.
  16. 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.
  17. Matheny, K-J, 1996. "Output Targeting and an Argument for Stabilization Policies," Purdue University Economics Working Papers 1092, Purdue University, Department of Economics.
  18. 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.
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