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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- Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
- Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
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- Howitt, Peter W, 1981. "Activist Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 249-69, April.
- Barro, Robert J., 1976. "Rational expectations and the role of monetary policy," Journal of Monetary Economics, Elsevier, vol. 2(1), pages 1-32, January.
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- Poole, William, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 197-216, May.
- William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
- 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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