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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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