Monetary Policy in Real Time: The Role of Simple Rules
15 Pages Posted: 18 Apr 2019
Date Written: April 1, 2003
Setting the interest rate in an inflation targeting regime requires a total assessment, often translated into forecasts, of the outlook for inflation and real activity. In the assessment process, it is useful to have some references or cross-checks, in terms of simple rules. Although simple rules should not be followed mechanically, they provide a device for structuring and disciplining assessments. In addition, simple rules can also be useful as a checkpoint on whether or not monetary policy is “on track”. The Taylor rule is one such, but is in practice difficult to calculate in real time. Data on output are often revised substantially, making real-time estimates of the output gap highly uncertain. We therefore consider alternative Taylor-type rules that do not require information about current gross domestic product (GDP). The rules are assessed by their ability to mimic the ex post Taylor rule. Despite uncertainty about the natural rate of unemployment, we find that the unemployment gap is a good indicator of the “true” output gap, i.e. the output gap that can be calculated ex post with the benefit of hindsight. An alternative that combines information on wage and credit growth is also able to mimic the behaviour of the ex post Taylor rule quite closely. The role of simple rules as a tool for detecting monetary policy misalignments is discussed with reference to monetary policy in Norway after 1995.
Keywords: monetary policy, real time, Taylor rule
JEL Classification: E52, E58
Suggested Citation: Suggested Citation