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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. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
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    3. Bennett T. McCallum & Edward Nelson, . "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," GSIA Working Papers 1997-71, Carnegie Mellon University, Tepper School of Business.
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    6. Lars E.O. Svensson, 2002. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Working Papers 118, Princeton University, Department of Economics, Center for Economic Policy Studies..
    7. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
    8. Berg, Claes & Jonung, Lars, 1998. "Pioneering Price Level Targeting:The Swedish Experience 1931-1937," SSE/EFI Working Paper Series in Economics and Finance 290, Stockholm School of Economics.
    9. Svensson, Lars E.O., 1997. "Inflation Forecast Targeting: Implementing and Monitoring Inflation Targets," Seminar Papers 615, Stockholm University, Institute for International Economic Studies.
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    22. 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.
    23. 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.
    24. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price-level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.
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