Designing instrument rules for monetary stability: the optimality of interest-rate smoothing
AbstractA key issue in monetary policy is that on the importance of following systematic behaviours. The paper revisits the classic debate on rules versus discretion focusing on the design of instrument rules in a manner that push discretionary policy choices in the direction of the commitment equilibrium. It is shown that an instrument rule with an optimal degree of monetary inertia may render negligible the inflationary bias associated with discretion without necessarily implying a trade-off between flexibility and commitment. The rationale for this surprising finding is found in the disciplining effect played by interest-rate smoothing on the incentive to create surprise inflation by reducing suddenly the interest rate within the time horizon of existing nominal contracts. If the degree of gradualism is high it may enhance the credibility of optimal monetary policy as it contrasts the incentive to fool private sector. Keywords; monetary policy, instrument rules, commitment, discretion, interest-rate smoothing, delegation JEL classification: E52, E58
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Bibliographic InfoPaper provided by Economics Division, School of Social Sciences, University of Southampton in its series Discussion Paper Series In Economics And Econometrics with number 0008.
Date of creation: 01 Jan 2000
Date of revision:
Find related papers by JEL classification:
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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