“Having looked at monetary policy from both sides now, I can testify that central banking in practice is as much art as science. Nonetheless, while practicing this dark art, I have always found the science quEite useful.” 2 Alan S. Blinder

We estimate a forward-looking monetary policy reaction function for the postwar United States economy, before and after Volcker’s appointment as Fed Chairman in 1979. Our results point to substantial differences in the estimated rule across periods. In particular, interest rate policy in the Volcker-Greenspan period appears to have been much more sensitive to changes in expected in�ation than in the pre-Volcker period. We then compare some of the implications of the estimated rules for the equilibrium properties of in�ation and output, using a simple macroeconomic model, and show that the Volcker-Greenspan rule is stabilizing. I.

Policy rules that are consistent with ination targeting are examined in a small macroeconometric model of the US economy. We compare the properties and outcomes of explicit instrument rules as well as targeting rules. The latter, which imply implicit instrument rules, may be closer to actual operating procedures of inflation-targeting central banks. We find that ination forecasts are central for good policy rules under inflation targeting. Some simple instrument and targeting rules do remarkably well relative to the optimal rule; others, including some that are often used as representing inflation targeting, do less well.

The purpose of this paper is to survey and discuss inflation targeting in the context of monetary policy rules, to clarify the essential characteristics of in‡ation targeting, to compare inflation targeting to other monetary policy rules, and to draw some conclusions for the monetary policy of

The paper extends previous analysis of closed-economy inflation targeting to a small open economy with forward-looking aggregate supply and demand with some microfoundations, and with stylized realistic lags in the different transmission channels for monetary policy. The paper compares targeting of CPI and domestic inflation, strict and exible inflation targeting, and inflation-targeting reaction functions and the Taylor rule. The optimal monetary policy response to several different shocks is examined. Flexible CPI-inflation targeting stands out as successful in limiting not only the variability of CPI inflation but also the variability of the output gap and the real exchange rate. Somewhat counter to conventional wisdom, negative productivity supply shocks and positive demand shocks have similar effects on inflation and the output gap, and induce similar monetary policy responses. The model gives limited support for a so-called monetary conditions index, MCI, of the monetary-policy impact on aggregate d...

Contents 4 A Neo-Wicksellian Framework 1 1 ABasicModeloftheE#ectsofMonetaryPolicy................ 3 1.1 AnIntertemporalISRelation ...................... 4 1.2 ACompleteModel ............................ 9 2 Interest-Rate Rules and Price Stability ..................... 12 2.1 TheNaturalRateofInterest....................... 12 2.2 Conditions for Determinacy of Equilibrium ............... 18 2.3 Determinants of Inflation ......................... 32 2.4 Policy Rules for Inflation Stabilization ................. 41 3 MonetaryPolicyandInvestmentDynamics................... 45 3.1 InvestmentDemandwithStickyPrices................. 46 3.2 OptimalPrice-SettingwithEndogenousCapital............ 51 3.3 ComparisonwiththeBaselineModel .................. 56 3.4 CapitalandtheNaturalRateofInterest ................ 67 Chapter 4 A Neo-Wicksellian Framework for the Analysis of Monetary Policy We are now ready to consider the e#ects of alternative interest-ra

We examine to what extent variants of inflation-forecast targeting can avoid stabilization bias, incorporate history-dependence, and achieve determinacy of equilibrium, so as to reproduce a socially optimal equilibrium. We also evaluate these variants in terms of the transparency of the connection with the ultimate policy goals and the robustness to model perturbations. A suitably designed inflation-forecast targeting rule can achieve the social optimum and at the same time have a more transparent connection to policy goals and be more robust than competing instrument rules.

The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of England. We have benefited greatly from the comments and suggestions of Bill

This paper investigates how monetary policy should be conducted in a two-region, general equilibrium model with monopolistic competition and price stickiness. This framework delivers a simple welfare criterion based on the utility of the consumers that has the usual tradeoff between stabilizing inflation and output. If the two regions share the same degree of nominal rigidity, the terms of trade are completely insulated from monetary policy and the optimal outcome is obtained by targeting a weighted average of the regional inflation rates. These weights coincide with the economic sizes of the region. If the degrees of rigidity are different, the optimal plan implies a high degree of inertia in the inflation rate. But an inflation targeting policy in which higher weight is given to the inflation in the region with higher degree of nominal rigidity is nearly optimal.

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