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Monetary Policy, Interest Rate Rules, and Inflation Targeting: Some Basic Equivalences

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  • Carlos A. Vegh

Abstract

Policymakers increasingly view short-term nominal interest rates as the main instrument of monetary policy, often in conjunction with some inflation target. Interest rates on short-term indexed government debt (i.e., a real interest rate) have also been used as policy instruments. To understand the pros and cons of different policy rules and instruments, this paper derives some basic equivalences among different policy rules. It is shown that, under certain conditions, the following three rules are exactly equivalent: (i) a 'k-percent' money growth rule; (ii) a nominal interest rate rule combined with an inflation target; and (iii) a real interest rate rule combined with an inflation target. These policy rules, however, become increasingly complex: the first rule requires no feedback mechanism; the second rule requires responding to the inflation gap; while the third rule involves responding to both the inflation gap and the output gap. It is also shown that policy rules which respond to the output gap may avoid a deflationary adjustment.

Suggested Citation

  • Carlos A. Vegh, 2001. "Monetary Policy, Interest Rate Rules, and Inflation Targeting: Some Basic Equivalences," NBER Working Papers 8684, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8684
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    Cited by:

    1. Horacio A. Aguirre, 2011. "On the “Science” of Monetary Policy: Methodological Notes," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(64), pages 83-115, October -.
    2. Elizabeth Bucacos & Gerardo Licandro, 2002. "Acerca de la estabilidad de la demanda de dinero. El caso de Uruguay: 1979.4-2002.3," Documentos de trabajo 2002001, Banco Central del Uruguay.
    3. Erdin MALOKU, 2011. "Role of Central Bank in the Establishment and the Development of Financial System in Post-War Kosovo," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 1(5), pages 1-14, August.
    4. Andreas Schabert, "undated". "On the Equivalence of Money Growth and Interest Rate Policy," Working Papers 2003_6, Business School - Economics, University of Glasgow, revised Apr 2003.
    5. Mr. Alejandro D Guerson, 2015. "Inflation Dynamics and Monetary Policy in Bolivia," IMF Working Papers 2015/266, International Monetary Fund.
    6. By Alexander W. Hoffmaister, 2001. "Inflation Targeting in Korea: An Empirical Exploration," IMF Staff Papers, Palgrave Macmillan, vol. 48(2), pages 1-5.
    7. Chin, Chi-Ting & Guo, Jang-Ting & Lai, Ching-Chong, 2009. "Macroeconomic (in)stability under real interest rate targeting," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1631-1638, September.
    8. Chaouech, Olfa, 2015. "Taylor rule in practice : Evidence from tunisia," MPRA Paper 66771, University Library of Munich, Germany, revised 18 Sep 2015.
    9. Shigeto Kitano, 2007. "Capital Controls, Public Debt and Currency Crises," Journal of Economics, Springer, vol. 90(2), pages 117-142, March.
    10. Chaouech, Olfa, 2015. "Taylor rule in practice: Evidence from Tunisia," MPRA Paper 74628, University Library of Munich, Germany, revised 16 Oct 2016.
    11. Schabert, Andreas, 2009. "Money supply, macroeconomic stability, and the implementation of interest rate targets," Journal of Macroeconomics, Elsevier, vol. 31(2), pages 333-344, June.
    12. Nejla Adanur Aklan & Mehmet Nargelecekenler, 2008. "Taylor Rule in Practice: Evidence from Turkey," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 14(2), pages 156-166, May.
    13. Schabert, Andreas, 2005. "Money Supply and the Implementation of Interest Rate Targets," CEPR Discussion Papers 5094, C.E.P.R. Discussion Papers.
    14. repec:kap:iaecre:v:14:y:2008:i:2:p:156-166 is not listed on IDEAS
    15. Lai, Ching-Chong & Chin, Chi-Ting, 2013. "Monetary Rules And Endogenous Growth In An Open Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 17(2), pages 431-463, March.

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    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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