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Monetary policy rules and a normative approach to the central bank’s objective function

Author

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  • Máté Barnabás Tóth

    () (Magyar Nemzeti Bank (central bank of Hungary))

Abstract

This study attempts to explain in an understandable manner that the central bank’s effort to keep inflation low is not an end in itself, but ultimately serves the interests of social welfare. We attempt to substantiate this argument on the basis of economic theory, based on the logic of New Keynesian models, by describing loss functions that contain welfare relevant variables and interest rules that minimise them. By using this framework, we point out that – taking into account the limits of measurability, learning and potentially non-rational expectations – decision-making rules that give considerable weight to a departure from the inflation target and take into account real economy considerations generally perform well in terms of welfare and may be considered robust in New Keynesian-type models with forward looking agents. Finally, we argue that through the strategy of inflation targeting the normative implications of the above framework can be put into practice.

Suggested Citation

  • Máté Barnabás Tóth, 2007. "Monetary policy rules and a normative approach to the central bank’s objective function," MNB Bulletin (discontinued), Magyar Nemzeti Bank (Central Bank of Hungary), vol. 2(2), pages 39-46, November.
  • Handle: RePEc:mnb:bullet:v:2:y:2007:i:2:p:39-46
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    File URL: http://www.mnb.hu/letoltes/toth-en.pdf
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    More about this item

    Keywords

    New_keynesian model; inflation targeting; normative approach.;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • 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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