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On the Optimal Adherence to Money Targets in a New-Keynesian Framework; An Application to Low-Income Countries

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  • Andrew Berg
  • Filiz D Unsal
  • Rafael A Portillo

Abstract

Many low-income countries continue to describe their monetary policy framework in terms of targets on monetary aggregates. This contrasts with most modern discussions of monetary policy, and with most practice. We extend the new-Keynesian model to provide a role for “M” in the conduct of monetary policy, and examine the conditions under which some adherence to money targets is optimal. In the spirit of Poole (1970), this role is based on the incompleteness of information available to the central bank, a pervasive issues in these countries. Ex-ante announcements/forecasts for money growth are consistent with a Taylor rule for the relevant short-term interest rate. Ex-post, the policy maker must choose his relative adherence to interest rate and money growth targets. Drawing on the method in Svensson and Woodford (2004), we show that the optimal adherence to ex-ante targets is equivalent to a signal extraction problem where the central bank uses the money market information to update its estimate of the state of the economy. We estimate the model, using Bayesian methods, for Tanzania, Uganda (both de jure money targeters), and Ghana (a de jure inflation targeter), and compare the de facto adherence to targets with the optimal use of money market information in each country.

Suggested Citation

  • Andrew Berg & Filiz D Unsal & Rafael A Portillo, 2010. "On the Optimal Adherence to Money Targets in a New-Keynesian Framework; An Application to Low-Income Countries," IMF Working Papers 10/134, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:10/134
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    References listed on IDEAS

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    Cited by:

    1. Yuko Hashimoto & Konstantin M. Wacker, 2012. "The Role of Risk and Information for International Capital Flows: New Evidence from the SDDS," Courant Research Centre: Poverty, Equity and Growth - Discussion Papers 124, Courant Research Centre PEG.
    2. Andrew Berg & Luisa Charry & Rafael A Portillo & Jan Vlcek, 2013. "The Monetary Transmission Mechanism in the Tropics; A Narrative Approach," IMF Working Papers 13/197, International Monetary Fund.
    3. Michal Andrle & Andrew Berg & Enrico G Berkes & Rafael A Portillo & Jan Vlcek & R. Armando Morales, 2013. "Money Targeting in a Modern Forecasting and Policy Analysis System; an Application to Kenya," IMF Working Papers 13/239, International Monetary Fund.
    4. Helge Berger & Henning Weber, 2012. "Money As Indicator for the Natural Rate of Interest," IMF Working Papers 12/6, International Monetary Fund.
    5. Francis Leni Anguyo & Rangan Gupta & Kevin Kotze, 2017. "Monetary Policy and Financial Frictions in a Small Open-Economy Model for Uganda," School of Economics Macroeconomic Discussion Paper Series 2017-01, School of Economics, University of Cape Town.
    6. Alexandra Born & Sarwat Jahan & Edward R Gemayel, 2011. "What Can Low-Income Countries Expect From Adopting Inflation Targeting?," IMF Working Papers 11/276, International Monetary Fund.

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    Keywords

    Monetary policy; Incomplete Information; Money Targets; Low-Income Countries; inflation; central bank; money demand; money growth; Asymmetric and Private Information;

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