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The Monetary Transmission Mechanism and the Evaluation of Monetary Policy Rules

In: Monetary Policy: Rules and Transmission Mechanisms

  • John B. Taylor

    (Stanford University)

This paper shows that different models of the monetary transmission mechanism lead to surprisingly similar choices about monetary policy rules. In particular, simple rules in which the interest rate reacts to inflation and real output seem to be robust to many different views about how monetary policy works. In models of small open economies—where the monetary transmission mechanism has a relatively strong exchange rate channel—the policy rule should also adjust to the exchange rate, but the gains from such exchange rate rules over rules that react only to inflation and output are small. The results suggest the need for more research on both the effect of exchange rate fluctuations and on policy rules that take account of exchange rates.

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This chapter was published in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Monetary Policy: Rules and Transmission Mechanisms, , chapter 2, pages 021-046, 2002.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v04c02pp021-046.
Handle: RePEc:chb:bcchsb:v04c02pp021-046
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  1. 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.
  2. Rudebusch, G.D. & Svensson, L.E.O., 1998. "Policy Rules for Inflation Targeting," Papers 637, Stockholm - International Economic Studies.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  4. Simon Gilchrist & Ben S. Bernanke & Mark Gertler, 1994. "The financial accelerator and the flight to quality," Finance and Economics Discussion Series 94-18, Board of Governors of the Federal Reserve System (U.S.).
  5. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," Econometrica, Econometric Society, vol. 68(5), pages 1151-1180, September.
  6. Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor Rules in a Limited Participation Model," NBER Working Papers 7017, National Bureau of Economic Research, Inc.
  7. Jeffrey C. Fuhrer & Brian F. Madigan, 1997. "Monetary Policy When Interest Rates Are Bounded At Zero," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 573-585, November.
  8. 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.
  9. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Working Paper Series, Macroeconomic Issues WP-96-28, Federal Reserve Bank of Chicago.
  10. 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.
  11. Taylor, John B & Uhlig, Harald, 1990. "Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 1-17, January.
  12. John C. Williams, 1999. "Simple rules for monetary policy," Finance and Economics Discussion Series 1999-12, Board of Governors of the Federal Reserve System (U.S.).
  13. Brayton, Flint & Levin, Andrew & Lyon, Ralph & Williams, John C., 1997. "The evolution of macro models at the Federal Reserve Board," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 43-81, December.
  14. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  15. Aaron Drew & Ben Hunt, 1998. "The Forecasting and Policy System: preparing economic projections," Reserve Bank of New Zealand Discussion Paper Series G98/7, Reserve Bank of New Zealand.
  16. Laurence Ball, 1997. "Efficient rules for monetary policy," Reserve Bank of New Zealand Discussion Paper Series G97/3, Reserve Bank of New Zealand.
  17. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  18. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  19. Fair, Ray C & Taylor, John B, 1983. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 51(4), pages 1169-85, July.
  20. Andrew T. Levin & Volker W. Wieland & John C. Williams, 1998. "Robustness of simple monetary policy rules under model uncertainty," Finance and Economics Discussion Series 1998-45, Board of Governors of the Federal Reserve System (U.S.).
  21. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
  22. John B. Taylor, 1995. "The monetary transmission mechanism: an empirical framework," Working Papers in Applied Economic Theory 95-07, Federal Reserve Bank of San Francisco.
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