IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

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.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL:
    File Function: First Version, 2014
    Download Restriction: no

    Paper provided by Pakistan Institute of Development Economics in its series PIDE-Working Papers with number 2014:102.

    in new window

    Length: 28 pages
    Date of creation: 2014
    Date of revision:
    Handle: RePEc:pid:wpaper:2014:102
    Contact details of provider: Postal: P.O.Box 1091, Islamabad-44000
    Phone: (92)(51)9248051
    Fax: (92)(51)9248065
    Web page:

    More information through EDIRC

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    2. 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.
    3. Coenen, Gunter & Levin, Andrew & Wieland, Volker, 2005. "Data uncertainty and the role of money as an information variable for monetary policy," European Economic Review, Elsevier, vol. 49(4), pages 975-1006, May.
    4. 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.
    5. Meade, James E., 1977. "The Meaning of "Internal Balance"," Nobel Prize in Economics documents 1977-2, Nobel Prize Committee.
    6. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
    7. Mervyn King, 1994. "Monetary policy in the UK," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 109-28, August.
    8. Adam S. Posen, 1995. "Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 253-274 National Bureau of Economic Research, Inc.
    9. 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.
    10. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
    11. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
    12. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
    13. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    14. Michael T. Kiley, 1998. "Monetary policy under neoclassical and New-Keynesian Phillips Curves, with an application to price level and inflation targeting," Finance and Economics Discussion Series 1998-27, Board of Governors of the Federal Reserve System (U.S.).
    15. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    16. Nicoletta Batini & Anthony Yates, 2001. "Hybrid inflation and price level targeting," Bank of England working papers 135, Bank of England.
    17. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
    18. Berg, C. & Jonung, L., 1998. "Pioneering Price Level Targeting: The Swedish Experience 1931-1937," Papers 642, Stockholm - International Economic Studies.
    19. Goodfriend, Marvin, 1987. "Interest rate smoothing and price level trend-stationarity," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 335-348, May.
    20. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
    21. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    22. Frederic S. Mishkin, 1996. "The Channels of Monetary Transmission: Lessons for Monetary Policy," NBER Working Papers 5464, National Bureau of Economic Research, Inc.
    23. Charles R. Bean, 2004. "Asset Prices, Financial Instability, and Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 14-18, May.
    24. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
    25. James Peery Cover & Paul Pecorino, 2005. "Price and Output Stability under Price-Level Targeting," Southern Economic Journal, Southern Economic Association, vol. 72(1), pages 152–166, July.
    26. 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.
    27. Lewis, Mervyn K. & Mizen, Paul D., 2000. "Monetary Economics," OUP Catalogue, Oxford University Press, number 9780198290629.
    28. 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.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:pid:wpaper:2014:102. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Khurram Iqbal)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.