Comments in response to Lars Svensson's “Targeting vs. Instrument Rules for Monetary Policy: What Is Wrong with McCallum and Nelson?”
Svensson's (2003) argument that targeting rules are normatively superior to instrument rules for conducting monetary policy is based largely on four main objections to the latter, plus a claim concerning the relative interest-instrument variability entailed by the two approaches. We advance arguments that contradict his objections and discuss general targeting rules and actual central bank practice.
McCallum and Nelson's critique of targeting rules for monetary policy are rebutted. Their preference to study the robustness of simple monetary policy rules is no reason to limit attention to simple instrument rules; simple targeting rules may be more desirable. 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. Under realistic assumptions, the instrument rule analog to any targeting rule the authors propose results in very large instrument rate volatility and is, for other reasons, inferior.
This paper revisits the debate of the money supply versus the interest rate as the instrument of monetary policy. The authors use a dynamic stochastic general equilibrium framework to examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables; they show that inflation persistence and the variability of inflation relative to money growth depend on whether the central bank follows a money growth rule or an interest rate rule.
This article was originally presented as a speech to the Money Marketeers, New York, New York, June 14, 2005.