NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Targeting Rules vs. Instrument Rules for Monetary Policy: What is Wrong with McCallum and Nelson?

Lars E.O. Svensson

NBER Working Paper No. 10747
Issued in September 2004
NBER Program(s):   ME

McCallum and Nelson's (2004) criticism of targeting rules for the analysis of monetary policy is rebutted. First, McCallum and Nelson's preference to study the robustness of simple monetary-policy rules is no reason at all to limit attention to simple instrument rules; simple targeting rules may have more desirable properties. Second, optimal targeting rules are a compact, robust, and structural description of goal-directed monetary policy, analogous to the compact, robust, and structural consumption Euler conditions in the theory of consumption. They express the very robust condition of equality of the marginal rates of substitution and transformation between the central bank's target variables. Third, under realistic information assumptions, the instrument-rule analogue to any targeting rule that McCallum and Nelson have proposed results in very large instrument-rate volatility and is also for other reasons inferior to a targeting rule.

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Document Object Identifier (DOI): 10.3386/w10747

Published: Svensson, Lars E. O. "Targeting Rules Versus Instrument Rules For Monetary Policy: What Is Wrong With McCallum And Nelson?," Federal Reserve Bank of St. Louis Review 87(5): 613-625, Sep/Oct 2005

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