NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Targeting vs. Instrument Rules for Monetary Policy

Bennett T. McCallum, Edward Nelson

NBER Working Paper No. 10612
Issued in July 2004
NBER Program(s):   EFG   ME

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.

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Document Object Identifier (DOI): 10.3386/w10612

Published: McCallum, Bennett T. and Edward Nelson. "Targeting Versus Instrument Rules For Monetary Policy," FRB St. Louis - Review, 2005, v87(5,Sep/Oct), 597-611. citation courtesy of

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