Monetary instruments and policy rules in a rational expectations environment
This paper explores the implications of rational expectations and the aggregate supply theory advanced by Lucas (1973) for analysis of optimal monetary policy under uncertainty along the lines of Poole (1970), returning to a topic initially treated by Sargent and Wallace (1975). Not surprisingly, these two "classical"concepts alter both the menu of feasible policy choice and the desirability of certain policy actions. In our setup, unlike that of Sargent and Wallace (1975),the systematic component of monetary policy is a relevant determinant of the magnitudeof "business fluctuations" that arise from shocks to the system. Central bank behavior--both the selection of monetary instruments and the framing of overall policyrespJnse to economic conditions--can work to diminish or increase the magnitude of business fluctuations. However, the "activist" policies stressed by the present discussion bear little (if any) relationship to the policy options rationalized by the conventional analysis of monetary policy under uncertainty. In particular,in contrast to Poole's analysis, money supply responses to the nominal interestrate are not important determinants of real economic activity. Rather, the central bank should focus on policies that make movements in the general price level readily identifiable by economic agents.
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- William Poole, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, Oxford University Press, vol. 84(2), pages 197-216.
- Santomero, Anthony M & Siegel, Jeremy J, 1981. "Bank Regulation and Macro-Economic Stability," American Economic Review, American Economic Association, vol. 71(1), pages 39-53, March.
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- McCallum, B. T. & Whitaker, J. K., 1979. "The effectiveness of fiscal feedback rules and automatic stabilizers under rational expectations," Journal of Monetary Economics, Elsevier, vol. 5(2), pages 171-186, April.
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- William Poole, 1970.
"Optimal choice of monetary policy instruments in a simple stochastic macro model,"
57, Board of Governors of the Federal Reserve System (U.S.).
- William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
- Laurence Weiss, 1978.
"The Role for Active Monetary Policy in a Rational Expectations Model,"
Cowles Foundation Discussion Papers
491, Cowles Foundation for Research in Economics, Yale University.
- Weiss, Laurence M, 1980. "The Role for Active Monetary Policy in a Rational Expectations Model," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 221-33, April.
- Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
- McCallum, Bennett T, 1980. "Rational Expectations and Macroeconomic Stabilization Policy: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 716-46, November.
- Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
- Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
- Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
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