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Instrument versus Target Rules As Specifications of Optimal Monetary Policy

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  • Richard T. Froyen
  • Alfred V. Guender

Abstract

Central banks frequently apply target rules or instrument rules in the conduct of monetary policy. For a central bank with multiple target variables such as the Federal Reserve's ‘dual mandate’, a target rule expresses the desired values for each target and the relative weight given to each. The so-called Taylor rule, in which the central bank chooses how to respond to the output gap and inflation, is an example of an instrument rule. This paper sets out the parameters of ‘optimal’ target and instrument rules and analyses their relative merits. In contrast to Svensson and Woodford, we find that target rules offer no clear advantages over optimal instrument rules. From a policy perspective, this suggests that the case for target rules has been overstated. The use of optimal instrument rules accords with current Federal Reserve practice whereby the federal funds rate responds to optimal forecasts – those using all available information.

Suggested Citation

  • Richard T. Froyen & Alfred V. Guender, 2012. "Instrument versus Target Rules As Specifications of Optimal Monetary Policy," International Finance, Wiley Blackwell, vol. 15(1), pages 99-123, April.
    • Handle: RePEc:bla:intfin:v:15:y:2012:i:1:p:99-123
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    File URL: http://hdl.handle.net/10.1111/j.1468-2362.2012.01299.x
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    References listed on IDEAS

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    Cited by:

    1. George Selgin, 2016. "Real and Pseudo Monetary Rules," Cato Journal, Cato Journal, Cato Institute, vol. 36(2), pages 279-296, Spring/Su.
    2. Maciej Ryczkowski, 2016. "Poland as an inflation nutter:The story of successful output stabilization," Zbornik radova Ekonomskog fakulteta u Rijeci/Proceedings of Rijeka Faculty of Economics, University of Rijeka, Faculty of Economics and Business, vol. 34(2), pages 363-392.

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