TY  - JOUR
AU  - McCallum,Bennett T.
TI  - Should Monetary Policy Respond Strongly to Output Gaps?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 8226
PY  - 2001
Y2  - April 2001
UR  - http://www.nber.org/papers/w8226
L1  - http://www.nber.org/papers/w8226.pdf
N1  - Author contact info:
Bennett T. McCallum
Tepper School of Business, Posner 256
Carnegie Mellon University
Pittsburgh, PA 15213
Tel: 412/268-2347
Fax: 412/268-6830
E-Mail: bm05@andrew.cmu.edu
AB  - Much recent monetary policy analysis has featured stochastic simulations with small structural macroeconomic models that include: a spending vs. saving ( IS') sector; a price-adjustment sector; and an interest rate policy rule.  The first two are frequently specified so as to reflect optimizing behavior; policy may or may not be specified as optimizing depending on the study's objectives.  Some leading issues concern modifications to simple quantitative optimizing models that are needed to generate realistic degrees of persistence in inflation and output-gap variables.  A major policy issue is whether it is desirable for monetary policy to respond strongly to the output gap.  The paper argues that the latter is unobservable and considers the implications of using a trend-type measure while the true concept is of a type more in keeping with basic theory.  In such circumstances, highly undesirable consequences are likely to ensue if policy responds strongly to the measured gap.
ER  -