Targeting vs. Instrument Rules for Monetary Policy

33 Pages Posted: 26 Jul 2004 Last revised: 2 Jul 2010

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Edward Nelson

Board of Governors of the Federal Reserve System

Date Written: July 2004

Abstract

Svensson (JEL, 2003) argues strongly that specific targeting rules first order optimality conditions for a specific objective function and model are normatively superior to instrument rules for the conduct of monetary policy. That argument is based largely upon four main objections to the latter plus a claim concerning the relative interest-instrument variability entailed by the two approaches. The present paper considers the four objections in turn, and advances arguments that contradict all of them. Then in the paper's analytical sections, it is demonstrated that the variability claim is incorrect, for a neo-canonical model and also for a variant with one-period-ahead plans used by Svensson, providing that the same decision-making errors are relevant under the two alternative approaches. Arguments relating to general targeting rules and actual central bank practice are also included.

Suggested Citation

McCallum, Bennett T. and Nelson, Edward, Targeting vs. Instrument Rules for Monetary Policy (July 2004). NBER Working Paper No. w10612, Available at SSRN: https://ssrn.com/abstract=565165

Bennett T. McCallum (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

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Edward Nelson

Board of Governors of the Federal Reserve System ( email )

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