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Choice of Monetary Policy Instrument under Targeting Regimes in a Simple Stochastic Macro Model

  • Haider Ali

    (Pakistan Institute of Development Economics, Islamabad)

  • Eatzaz Ahmad

    (Quaid-i-Azam University, Islamabad)

Registered author(s):

    This paper analyzes the relative performance of inflation and price-level targeting regimes in an AS-IS-LM framework under alternative policy instruments used by the central bank. Being general in its nature, the results are further used to derive equilibrium values of the important macroeconomic variables under the two targeting regimes for two limiting cases; when LM schedule becomes vertical (Quantity Theory of Money) and when it becomes horizontal (Endogenous Money Hypothesis). Contrary to Svensson’s findings, our results imply a ‘free lunch’ in case of inflation targeting rather than pricelevel targeting. Calibration results for Pakistan also support these theoretical findings and point towards inadequacy of using interest rate, rather than money supply, as a policy instrument both under the inflation and price level targeting regimes.

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    File URL: http://www.pide.org.pk/pdf/Working%20Paper/WorkingPaper-102.pdf
    File Function: First Version, 2014
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    Paper provided by Pakistan Institute of Development Economics in its series PIDE-Working Papers with number 2014:102.

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    Length: 28 pages
    Date of creation: 2014
    Date of revision:
    Handle: RePEc:pid:wpaper:2014:102
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    1. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
    2. James Tobin, 1980. "Stabilization Policy Ten Years After," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 19-90.
    3. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
    4. Lars E. O. Svensson, 1996. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," NBER Working Papers 5797, National Bureau of Economic Research, Inc.
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    9. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
    10. Nicoletta Batini & Anthony Yates, 2001. "Hybrid inflation and price level targeting," Bank of England working papers 135, Bank of England.
    11. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
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    25. Berg, Claes & Jonung, Lars, 1999. "Pioneering price level targeting: The Swedish experience 1931-1937," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 525-551, June.
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