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Targeting versus instrument rules for monetary policy

  • Bennett T. McCallum
  • Edward Nelson

Svensson (2003) argues strongly that specific targeting rules-first-order optimality conditions for a specific objective function and model-are normatively superior to instrument rules for the conduct of monetary policy. That argument is based largely on four main objections to the latter, plus a claim concerning the relative interest-instrument variability entailed by the two approaches. The present paper considers the four objections in turn and advances arguments that contradict all of them. Then, in the paper's analytical sections, it is demonstrated that the variability claim is incorrect, for a neo-canonical model and also for a variant with one-period-ahead plans used by Svensson, providing that the same decisionmaking errors are relevant under the two alternative approaches. Arguments relating to general targeting rules and actual central bank practice are also included.

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Article provided by Board of Governors of the Federal Reserve System (U.S.) in its journal Proceedings.

Volume (Year): (2005)
Issue (Month): ()
Pages: 225-245

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Handle: RePEc:fip:fedgpr:y:2005:p:225-245
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  1. Lars E.O. Svensson, 1998. "Inflation Targeting as a Monetary Policy Rule," NBER Working Papers 6790, National Bureau of Economic Research, Inc.
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  4. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
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  8. Bennett T. McCallum & Edward Nelson, . "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," GSIA Working Papers 1998-22, Carnegie Mellon University, Tepper School of Business.
  9. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
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