On the Optimal Choice of a Monetary Policy Instrument
The optimal choice of a monetary policy instrument depends on how tight and transparent the available instruments are and on whether policymakers can commit to future policies. Tightness is always desirable; transparency is only if policymakers cannot commit. Interest rates, which can be made endogenously tight, have a natural advantage over money growth and exchange rates, which cannot. As prices, interest and exchange rates are more transparent than money growth. All else equal, the best instrument is interest rates and the next-best, exchange rates. These findings are consistent with the observed instrument choices of developed and less-developed economies.
Atkeson, Chari, and Kehoe thank the National Science Foundation for financial support, Jon Faust and Nancy Stokey for useful discussions, particularly Stokey's  discussion of an earlier draft of this work, and Kathleen Rolfe and Joan Gieseke for excellent editorial assistance. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.