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Simple rules for monetary policy

  • John C. Williams

How effective are "simple" monetary policy rules at stabilizing the economy? This paper explores the characteristics and performance of monetary policy rules designed to minimize fluctuations in inflation, output, and interest rates using the Federal Reserve Board's large-scale FRB/US macroeconometric model. I find that a smoothed measure of inflation, the output gap, and the lagged funds rate are sufficient statistics for the setting of monetary policy. Efficient simple rules that respond to these three variables perform nearly as well as fully optimal policies that respond to the hundreds of variables in the model, and the simple rules are more robust to model misspecification. Efficient policies smooth the interest rate response to shocks and use the feedback from anticipated policy actions to stabilize inflation and output and to moderate movements in short-term interest rates. These results hold in a wide range of macro models but are sensitive to the assumption of rational expectations.

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Article provided by Federal Reserve Bank of San Francisco in its journal Economic Review.

Volume (Year): (2003)
Issue (Month): ()
Pages: 1-12

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Handle: RePEc:fip:fedfer:y:2003:p:1-12
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  13. Flint Brayton & Eileen Mauskopf & David Reifschneider & Peter Tinsley & John Williams, 1997. "The role of expectations in the FRB/US macroeconomic model," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 227-245.
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  19. Ray C. Fair & E. Philip Howrey, 1995. "Evaluating Alternative Monetary Policy Rules," Cowles Foundation Discussion Papers 1091, Cowles Foundation for Research in Economics, Yale University.
  20. Mccallum, Bennet T., 1988. "Robustness properties of a rule for monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 173-203, January.
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  24. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, vol. 49(3), pages 211-28, September.
  25. Henderson, Dale W. & McKibbin, Warwick J., 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 221-317, December.
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