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Policy rules and targets: framing the central banker's problem

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  • Stephen G. Cecchetti

Abstract

The author presents an analytical framework for the formulation of a central bank policy rule and examines some conceptual issues relating to the current debate over the effectiveness of such rules. In discussing the move by many central banks to adopt a price-level or inflation rate target--the basis for one type of rule--he suggests that central banks are implicitly changing the relative importance they attach to the goals of price and output stability. Using 1984-95 data, he shows that an effort to decrease inflation variability modestly could cause output to deviate significantly from its optimal path. The essay also addresses the influence of various types of uncertainty on policymaking, the possible justifications for interest rate smoothing, and the consequences of the fact that nominal interest rates cannot fall below zero.

Suggested Citation

  • Stephen G. Cecchetti, 1998. "Policy rules and targets: framing the central banker's problem," Economic Policy Review, Federal Reserve Bank of New York, vol. 4(Jun), pages 1-14.
    • Handle: RePEc:fip:fednep:y:1998:i:jun:p:1-14:n:v.4no.2
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    References listed on IDEAS

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    1. Lars E. O. Svensson, 1999. "Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Wiley Blackwell, vol. 101(3), pages 337-361, September.
    2. Laurence Ball, 1999. "Efficient Rules for Monetary Policy," International Finance, Wiley Blackwell, vol. 2(1), pages 63-83, April.
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    5. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530, Elsevier.
    6. Erica Groshen & Mark Schweitzer, 1999. "Identifying Inflation's Grease and Sand Effects in the Labor Market," NBER Chapters, in: The Costs and Benefits of Price Stability, pages 273-314, National Bureau of Economic Research, Inc.
    7. Cukierman, Alex & Kalaitzidakis, Pantelis & Summers, Lawrence H. & Webb, Steven B., 1993. "Central bank independence, growth, investment, and real rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 95-140, December.
    8. Alan S. Blinder, 1997. "Distinguished Lecture on Economics in Government: What Central Bankers Could Learn from Academics--And Vice Versa," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 3-19, Spring.
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    Cited by:

    1. Philip Arestis & Kostas Mouratidis, 2004. "Credibility of European Monetary System Interest Rate Policies: A Markov Regime‐Switching Approach," Manchester School, University of Manchester, vol. 72(1), pages 1-23, January.
    2. Vittorio Corbo, 2002. "Monetary Policy in Latin America in the 90s," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 6, pages 117-166, Central Bank of Chile.
    3. WenShwo Fang & Stephen M. Miller & ChunShen Lee, 2008. "Cross‐Country Evidence On Output Growth Volatility: Nonstationary Variance And Garch Models," Scottish Journal of Political Economy, Scottish Economic Society, vol. 55(4), pages 509-541, September.
    4. Vittorio Corbo & Klaus Schmidt-Hebbel, 2001. "Inflation Targeting in Latin America," Working Papers Central Bank of Chile 105, Central Bank of Chile.
    5. Ulf Söderström, 2002. "Monetary Policy with Uncertain Parameters," Scandinavian Journal of Economics, Wiley Blackwell, vol. 104(1), pages 125-145, March.
    6. Sergio Destefanis, 2003. "Measuring macroeconomic performance through a non-parametric Taylor curve," CSEF Working Papers 95, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    7. Philip Arestis & Kostas Mouratidis, 2004. "Is There a Trade‐Off Between Inflation Variability and Output‐Gap Variability in the EMU Countries?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 51(5), pages 691-706, November.
    8. Ben Martin, 1999. "Caution and gradualism in monetary policy under uncertainty," Bank of England working papers 105, Bank of England.
    9. Stephen G. Cecchetti & Michael Ehrmann, 2002. "Does Inflation Targeting Increase Output Volatility?: An International Comparison of Policymakers' Preferences and Outcomes," Central Banking, Analysis, and Economic Policies Book Series, in: Norman Loayza & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy: Rules and Transmission Mechanisms, edition 1, volume 4, chapter 9, pages 247-274, Central Bank of Chile.
    10. Warwick J. McKibbin & Kanhaiya Singh, 2003. "Issues in the Choice of a Monetary Regime for India," Chapters, in: Kaliappa Kalirajan & Ulaganathan Sankar (ed.), Economic Reform and the Liberalisation of the Indian Economy, chapter 10, pages 221-274, Edward Elgar Publishing.
    11. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    12. M. D. Hayford & A. G. Malliaris, 2005. "How did the Fed react to the 1990s stock market bubble? Evidence from an extended Taylor rule," World Scientific Book Chapters, in: Economic Uncertainty, Instabilities And Asset Bubbles Selected Essays, chapter 14, pages 223-232, World Scientific Publishing Co. Pte. Ltd..
    13. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q II), pages 5-33.
    14. Söderström, Ulf, 1999. "Should central banks be more aggressive?," Working Paper Series 84, Sveriges Riksbank (Central Bank of Sweden).
    15. Robert Dittmar & William T. Gavin & Finn E. Kydland, 1999. "Price-level uncertainty and inflation targeting," Review, Federal Reserve Bank of St. Louis, vol. 81(Jul), pages 23-34.
    16. Frédérique SIBI, 2010. "Stability of Final Objective of the European Monetary Authorities," EcoMod2004 330600129, EcoMod.
    17. Canofari, Paolo & Di Bartolomeo, Giovanni, 2017. "Regime switches under policy uncertainty in monetary unions," European Journal of Political Economy, Elsevier, vol. 47(C), pages 124-132.
    18. Marc-Alexandre Sénégas, 2002. "La politique monétaire face à l'incertitude : un survol méthodologique des contributions relatives à la zone euro," Revue d'Économie Financière, Programme National Persée, vol. 65(1), pages 177-200.
    19. Kenneth N. Kuttner & Adam S. Posen, 1999. "Does talk matter after all? Inflation targeting and central bank behavior," Staff Reports 88, Federal Reserve Bank of New York.
    20. Spahn, Peter, 2012. "Integration durch Währungsunion? Der Fall der Euro-Zone," FZID Discussion Papers 57-2012, University of Hohenheim, Center for Research on Innovation and Services (FZID).
    21. J. Kilponen & Marc-Alexandre Sénégas & J. Vilmunen, 2006. "Bayesian versus robust control approach towards parameter uncertainty in monetary policymaking: how close are the outcomes? Some illustrating evidence from the EMU economies," Post-Print hal-00150522, HAL.
    22. International Monetary Fund, 2008. "Is Monetary Policy Effective When Credit is Low?," IMF Working Papers 2008/288, International Monetary Fund.
    23. Ronald G. Bodkin & Angel Enrique Neder, 2003. "Monetary Policy Targeting in Argentina and Canada in the 1990s: A Comparison, Some Contrasts, and a Tentative Evaluation," Eastern Economic Journal, Eastern Economic Association, vol. 29(3), pages 339-358, Summer.
    24. William T. Gavin, 2000. "Controlling inflation after Bretton Woods: an analysis based on policy objectives," Working Papers 2000-007, Federal Reserve Bank of St. Louis.

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