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Targeting versus instrument rules for monetary policy

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Abstract

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.

Suggested Citation

  • Bennett T. McCallum & Edward Nelson, 2005. "Targeting versus instrument rules for monetary policy," Review, Federal Reserve Bank of St. Louis, vol. 87(Sep), pages 597-612.
  • Handle: RePEc:fip:fedlrv:y:2005:i:sep:p:597-612:n:v.87no.5
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    More about this item

    Keywords

    Banks and banking; Central; Monetary policy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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